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Wednesday, September 17, 2008

Irving Underhill NYSE 1921New York Stock Exchange and Wilks Building at Wall and Broad Streets

Turning and turning in the widening gyreThe falcon cannot hear the falconer;Things fall apart; the centre cannot hold;Mere anarchy is loosed upon the world,The blood-dimmed tide is loosed, and everywhereThe ceremony of innocence is drowned;The best lack all conviction, while the worstAre full of passionate intensity.Yeats: The Second Coming

Ilargi: The US government and the Federal Reserve pulled out all the stops last night, laid all their weapons on the table, and stripped naked.

As noted yesterday, all the politicians that matter in Congress and Senate were present at the meeting that resulted in the AIG bail-out. They were there to make sure any illegal steps could be made legal in the wink of an eye.

Paulson and Bernanke have played havoc with the law lately, most recently when deciding stocks could be dumped at the Fed credit windows, and when allowing BoA to use its client deposits to go play in the casino.

So everybody was there, and the deal got done. Big sigh of relief, right? Well, no. The Dow is falling off a cliff, and the next group of financial institutions are lined up to be the fastest to fall. Do note, please, that today can be pinned down as the first day that the financial crisis spills over into corporate America for real.

Allow me to quote myself from last night:

"What this means is the start of what you might call finance anarchy. The US government has lost control, that much is clear to everyone now, or at least those who've been paying attention. As I've said, the companies will now be picked off one by one through shorting and swapping. The free market reaches its self-chosen and inevitable climax.

AIG has liabilities that run into the hundreds of billions of dollars, if not thousands. The vultures know this, make no mistake about it. So an $85 billion rescue is but a joke. It won't lift nothing for more than a few hours, probably not even long enough to last till the Dow opens tomorrow. There is blood in the water, and it's feeding time."

There are two converging problems at play here. One: the AIG deal doesn’t solve any of the issues that have built the crisis. Two: the US government is now out of ammunition, and it’s plain for everyone to see (not that everyone does see it). The emperor has nothing left to wear.

That means we can now conclude that the financial crisis has become a corporate and overall economic crisis. But there is more. We are witnessing the beginning of a political crisis as well.

There is no way that the financial downfall can be stopped, even temportarily, before the US elections. The government can now only try to negotiate mergers and private buy-outs. Its power and authority as a force in the markets is gone.

And as people see the world around them crumble, with mass-lay-offs, disappearing pension benefits and bank-runs, they will want to know who’s responsible. And that, of course, is the government: White House, Congress and Senate.

Hence, when Americans go to the polls in November, they can only vote for candidates that are directly, as senators, responsible for the crisis. They try hard to distance themselves from it, but that is mere posturing.

This is the sort of responsibilty that in a functioning democracy forces politicians to step down. This goes right to the heart of issues such as trust and legitimacy: people need to be able to call their elected representatives on their mistakes, whether they are honest ones or not.

I’ve long said that before the cascading failures start, we will see a round of consolidations. We have today arrived at that point. Wachovia and Morgan Stanley are in merger talks, the US government seeks a buyer for WaMu, Lloyds buys UK mortgage lender HBOS (HSBC wants in, but refuses to pay a single penny for HBOS shares).

Not all these talks will presumably be concluded in time to avoid bankruptcies, events are accelerating too fast. There is no trust whatsoever left in the system. For every successful deal, three more problems will emerge. It has to wind down till all the funny money has gone.

I said yesterday that Morgan Stanley looked to be under siege. It’s down over 40% this morning. It has entered the emergency room. And when Goldman gets under attack (down 25%), the picture is complete: Wall Street as a whole is crumbling.

There were bank runs at AIG affiliates yesterday in SIngapore. They won’t be the last, and they will hit closer to home. I wouldn’t be surprised if the Fed and Treasury will, in a sort of last gasp, bail out the FDIC as early as this weekend.

Dow, Sep 17, Closing numbers The Dow lost 4.06% today. Don't it make you wonder what would have happened without the AIG deal? And where is the next upshot supposed to come from this time? All major banks have huge losses, a total of at least $70 billion. That takes another $700-800 billion in available credit out of the system. In one day. It seems a lot, but it'll be a trifle soon when it all really starts to unfold and unwind. Kind of like how the Bear Stearns buy-out looked huge 6 months ago.

The U.S. Treasury said it will sell bills to allow the Federal Reserve to expand its balance sheet, a day after the government agreed to take over American International Group Inc.

"The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve," the department said in a statement today. "The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program."

Yesterday the Fed announced an $85 billion loan to AIG, in exchange for a 79.9 percent government stake in the largest U.S. insurer. The Fed also has set up several other emergency lending programs to provide Wall Street firms with ready access to funding. The new bill program "will provide cash for use in the Federal Reserve initiatives," the Treasury said.

The Treasury said it will sell the new bills using its existing auction procedures, giving "as much advance notification as possible." The bills will not have a uniform fixed term, giving the Treasury the same duration flexibility that it has with cash-management bills.

Pressure is building on the pristine "AAA" rating of the United States after a federal bailout of American International Group Inc, Standard & Poor's sovereign ratings committee chairman said on Wednesday. The $85 billion bailout of AIG on Tuesday by the U.S. Federal Reserve "has weakened the fiscal profile of the United States," S&P's John Chambers told Reuters in an interview.

"Lack of a pro-active stance could have resulted in further financial stress and put pressure on the U.S. triple-A rating," Chambers said. "There's no God-given gift of a AAA rating, and the U.S. has to earn it like everyone else."

S&P earlier this month affirmed the "AAA" sovereign rating of the United States, noting risks to the U.S. credit profile including the deteriorating credit profiles for most U.S. financial institutions over the past 12 months, S&P said in a September 3 statement.

Potential up-front costs to the government of maintaining financial stability could reach 24 percent of gross domestic product in the case of a "deep and prolonged recession," the report said. Chambers on Wednesday compared the U.S. rating to a lobster cooking in a pot of cold water.

"The lobster is still in the AAA pot and still moving," Chambers said. "The heat is turning up, but the water is still AAA stable." Chambers also called the AIG bailout "a signal event without precedent," adding: "This will be case studied for decades to come."

As the Bush administration has lurched from pillar to post in the financial crisis, some lawmakers and experts were considering a longer-term legislative solution that would create a new agency to dispose of the mortgage-related assets at the core of Wall Street’s woes.

Proponents of a more systematic government role to help relieve financial institutions of their toxic securities range from Lawrence H. Summers, the former Treasury secretary under President Clinton, to former Federal Reserve chairmen Paul A. Volcker and Alan Greenspan.

In Congress, the idea that is gaining traction centers on the creation of a new agency that would buy troubled assets from hobbled companies. The idea was floated on Tuesday by Barney Frank, Democrat of Massachusetts, who heads the House Financial Services Committee. Among those signaling that it merited serious consideration were Senate Majority Leader Harry Reid and the House speaker, Nancy Pelosi.

With seven weeks until the presidential elections, no one expects Congress or the White House to move quickly to create a new federal agency that puts taxpayers at risk for hundreds of billions of dollars in bad assets. Steny H. Hoyer, the House majority leader, said there was no time to consider any new proposals in the two weeks before Congress adjourns.

But in its ad hoc approach to the crisis, the Treasury Department and the Federal Reserve have, in effect, already embarked on a course similar to the proposals in Congress. In the case of Bear Stearns, the Fed took $29 billion of the investment bank’s mortgage-related assets as collateral for a Fed loan to JPMorgan Chase, which then agreed to acquire Bear Stearns.

In the case of Fannie Mae and Freddie Mac, the Treasury Department placed the companies in a conservatorship and explicitly backed the $5.3 trillion of mortgages they own or guarantee. Treasury also agreed to buy an unspecified amount of Fannie’s and Freddie’s mortgage-backed securities on the open market, starting with a $5 billion purchase this month.

Those securities are to be managed and ultimately sold for the government by an investment house on Wall Street. But federal officials remain concerned about the plight of other institutions, including Washington Mutual, the nation’s largest savings association. Experts estimate that a government bailout of Washington Mutual could cut in half the size of the federal deposit insurance fund, which protects bank depositors at thousands of banks and savings and loan institutions.

Mr. Frank was among the House and Senate leaders who were hastily called to a meeting Tuesday with the Federal Reserve chairman, Ben S. Bernanke, and Treasury Secretary Henry M. Paulson Jr. to hear about the Fed’s latest rescue plan, this time of the American International Group.

Mr. Frank said that one of the issues discussed in the meeting was a potential need for broader, longer-term federal action in the marketplace. “We have had a series of ad hoc interventions; this is one more ad hoc intervention,” he said. “I do think, because you can’t be sure this is the last one, the question of a broader more systemic action in which the government tries to help resolve these things is very important.”

In concept, the proposal would resemble the Resolution Trust Corporation, which disposed of bad assets held by hundreds of crippled savings institutions. Created in 1989, Resolution Trust closed or reorganized 747 institutions holding assets of nearly $400 billion. It did so by seizing the assets of troubled savings and loans and then reselling them to bargain-seeking investors.

By 1995, the S.& L. crisis abated and the agency was folded into the Federal Deposit Insurance Corporation, which Congress created during the Great Depression to regulate banks and protect the accounts of customers when they fail.

But the parallels to Resolution Trust are inexact. The federal government, unlike now, had no choice but to acquire the assets from savings associations because they were backed by federal deposit insurance. The mortgages now at the heart of Wall Street’s woes are not backed by federally insured deposits. Moreover, the mission of the corporation was to dispose of the assets as quickly as possible for maximum value. Its goal was to reduce taxpayer exposure.

In the current crisis, the goal is more debatable. Should the government be helping homeowners, housing or financial markets, or large companies in trouble? Moreover, policy makers already have been seeking ways to reduce the impact of hard-to-sell assets on the books of companies by encouraging healthier institutions to acquire troubled ones.

The issue is whether Congress, after the election, should create a more formal and accountable mechanism, such as a federal agency, that would provide a relief valve for the troubled assets now causing havoc on Wall Street.

“The question is, and it’s just a question, is, ‘Are we at the point where the private market has made so many bad decisions and is so depressed that it can’t get out from under?’ “ said Mr. Frank, who is planning to hold a hearing next week to explore whether Congress should create an agency to help the markets dispose of hard-to-sell assets.

“The question we have to address is, ‘Is it the case that market psychology has so depressed assets that no entity has capacity to buy and hold these assets except for the government?’ “ Mr. Frank said it would be more appropriate for a new agency, rather than the central bank, to be relieving the markets of the troubled assets. “It is not appropriate for the Federal Reserve either in a financial sense or in a democratic sense to take on this role,” Mr. Frank said in an interview.

But Senator Christopher J. Dodd of Connecticut, the chairman of the Senate banking committee, said at a news conference announcing hearings later this week on the crisis that he wondered whether such an agency was necessary if Treasury and the Fed were already performing such a function and had the authority to continue to do it.

“I’m not opposed to it,” he said of Mr. Frank’s proposal. “I’m anxious to hear what the administration would have to say about this.” Administration officials said they had no plans to make such a proposal, and that they would leave it to the next administration.

Mr. Frank emphasized that any legislation creating a new agency would have to be accompanied by “tough new regulations” to discourage companies from making more risky investments. He acknowledged that the decision about such an agency would be in the hands of the next Congress and the next president.

In recent days, aides to the presidential campaigns of John McCain and Barack Obama have said it would be premature to consider creating a new agency. But after the election, the political imperatives could significantly change, particularly if the housing markets remain depressed and Wall Street continues to choke on the billions of dollars in mortgage-backed assets.

Anxious investors continued to hack away at Morgan Stanley and Goldman Sachs Group Inc Wednesday, sending the two largest investment banks' shares lower and boosting default-insurance prices higher amid lingering worries about their ability to survive.

In early trade, shares of Morgan Stanley sank 13 percent to their lowest level in a decade, while Goldman Sachs fell 8 percent to a three-year low. So far this year, Goldman shares have fallen by 43 percent and Morgan's have lost half their value.

More distressing was the rise in the cost of protecting against a default in debt issued by the banks. The cost of protecting $10 million of Morgan debt against default for five years rose to $796,000 a year, up $40,000, according to CMA DataVision. Insurance policies on the debt, known as credit default swaps, were trading as though the firm were rated deep in junk territory at "B2" by Moody's, or 10 steps below its actual rating of "A1."

The cost of Goldman debt default insurance rose to $462,000 a year, up $16,000, trading as if the firm were rated "Ba3," nine steps below its actual "Aa3" rating at Moody's. The two remaining major Wall Street investment banks posted better-than-expected third-quarter results on Tuesday, but the news was not enough to slow the spreading fire.

"The credit crunch and credit contraction is intensifying," said Peter Boockvar, equity strategist at Miller Tabak & Co in New York. "The action in Morgan Stanley in light of what was better-than-expected numbers last night is disconcerting."

Morgan Stanley on Tuesday rushed to release its quarterly results after investors pushed its shares down 11 percent and led to widening swap spreads. Morgan out-earned the larger Goldman, which also exceeded analysts' expectations. Executives from both firms insisted their businesses remain vibrant and have performed well in unprecedented turmoil. Both argued they do not want or need to merge with a commercial bank.

Yet contraction in the capital markets has convinced some analysts that investment banks need to combine with big deposit-rich banks so they can tap pools of deposits for funding when debt and stock markets grow jittery. Yet the same panic that pushed Lehman Brothers Holdings Inc into bankruptcy and prompted Merrill Lynch & Co to seek a merger with Bank of America Corp continues to weigh on Goldman and Morgan Stanley.

The U.S. government seized control of American International Group Inc. -- one of the world's biggest insurers -- in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system.

The step marks a dramatic turnabout for the federal government, which had been strongly resisting overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government essentially pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to go under instead of giving it financial support. This time, the government decided AIG truly was too big to fail..The U.S. negotiators drove a hard bargain. Under terms hammered out Tuesday night, the Fed will lend up to $85 billion to AIG, and the U.S. government will effectively get a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. The two-year loan will carry an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)

The loan is secured by AIG's assets, including its profitable insurance businesses, giving the Fed some protection even if markets continue to sink. And if AIG rebounds, taxpayers could reap a big profit through the government's equity stake. "This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy," the Fed said in a statement.

It puts the government in control of a private insurer -- a historic development, particularly considering that AIG isn't directly regulated by the federal government. The Fed took the highly unusual step using legal authority granted in the Federal Reserve Act, which allows it to lend to nonbanks under "unusual and exigent" circumstances, something it invoked when Bear Stearns Cos. was rescued in March.

As part of the deal, Treasury Secretary Henry Paulson insisted that AIG's chief executive, Robert Willumstad, step aside. Mr. Paulson personally told Mr. Willumstad the news in a phone call on Tuesday, according to a person familiar with the call. Mr. Willumstad will be succeeded by Edward Liddy, the former head of insurer Allstate Corp.

AIG's bailout caps a tumultuous 10 days that have remade the American financial system. In that time, the government has engineered rescues that insert it deep into the housing and insurance industries, while Wall Street has watched two of its last four big independent brokerage firms exit the scene.

The U.S. on Sept. 6 took over mortgage-lending giants Fannie Mae and Freddie Mac as they teetered near collapse. This Sunday, the U.S. refused to bail out Wall Street pillar Lehman Brothers, which filed for bankruptcy-court protection and is now being sold off in pieces. That same day, another struggling Wall Street titan, Merrill Lynch & Co., agreed to sell itself to Bank of America Corp.

The AIG deal followed a day of high drama in Washington. The Treasury's Mr. Paulson and Federal Reserve Chairman Ben Bernanke convened in the early evening an unexpected meeting of top congressional leaders. Late in the trading day Tuesday, anticipation that the government might assist the insurer helped propel the Dow Jones Industrial Average to a 1.3% gain.

In bailing out AIG, the Federal Reserve appeared to be motivated in part by worries that Wall Street's financial crisis could begin to spill over into seemingly safe investments held by small investors, such as money-market funds that invest in AIG debt.Indeed, on Tuesday the $62 billion Primary Fund from the Reserve, a New York money-market firm, said it "broke the buck" -- that is, its net asset value fell below the $1-a-share level that funds like this must maintain.

Breaking the buck is an extremely rare occurrence. The fund was pinched by investments in bonds issued by now collapsing Lehman Brothers. Money-market funds are supposed to be among the safest investments available. No fund in the $3.6 trillion money-market industry has lost money since 1994, when Orange County, Calif., went bankrupt. A number of money-market funds own securities issued by AIG. The firm is also a big insurer of some money-market instruments.

In one $85 billion fell swoop, the U.S. Federal Reserve may have wiped out what credibility it won resisting Lehman Brothers' rescue plea and opened its door to countless other companies to come calling for cash.By providing a massive loan to American International Group on Tuesday, just two days after refusing to use public funds to save Lehman Brothers from bankruptcy, the central bank also invited tough questions on how exactly it determined whether a company was too big to fail.

Between the $29 billion the Fed pledged to swing the Bear Stearns sale to JPMorgan in March, $100 billion apiece to rescue mortgage finance firms Fannie Mae and Freddie Mac, up to $300 billion for the Federal Housing Authority, Tuesday's $85 billion loan to insurer AIG and various other rescue deals and loans, taxpayers are potentially on the hook for more than $900 billion.

"They pretended they were drawing a line in the sand with Lehman Brothers but now two days later they're doing another bailout," said Nouriel Roubini, a professor at New York University's Stern School of Business. "We're essentially continuing a system where profits are privatized and...losses socialized," Roubini said, adding that auto makers, airlines and other struggling businesses would no doubt be asking for government help too.

The government was hard pressed to say no to AIG because of concerns that its collapse would harm thousands of companies around the world and cause chaos in the $62 trillion market for credit default swaps, where it is a big player.

Many on Wall Street were clamouring for a rescue earlier on Tuesday, and AIG's share price swung wildly throughout the day as rumours swirled of an on again, off again government rescue.

But Roubini said instead of handing out money to firms that made bad bets -- which could inadvertently encourage more risky behaviour if companies think they have a safety net -- the government should be buying up mortgages and rewriting the terms so that households are not buried in debt.

To be sure, the Fed attached quite a few strings to its AIG funding deal. The loan carries a high interest rate, the government can veto any dividends, and AIG is expected to sell assets over the next two years to repay its debt. Senior management will be replaced.

But the central bank also followed a pattern established with Bear Stearns in March and repeated with Fannie and Freddie earlier this month of essentially wiping out shareholders while protecting those who held debt.Some economists warned that investors had caught on and were betting on future bailouts by selling stock and buying bonds in struggling firms. That ends up pushing down a company's share price, which can exacerbate its troubles.

"If the message is that any time something like this pops up we're going to wipe out the equity and coddle the bondholders, that is its own sort of moral hazard," said Michael Feroli, an economist with JPMorgan in New York. "I don't think you have to be a die-hard free market advocate to be at least a little bit concerned."

Fed officials said that they needed to act because of AIG's extensive involvement in financial markets. Through its insurance, risk and asset management businesses, AIG has dealings with many thousands of companies all over the world, so a bankruptcy would have had huge global repercussions.

RBC Capital Markets analyst Hank Calenti pegged the market impact of an AIG failure at more than $180 billion, or about half of the total capital that financial firms have raised since the beginning of the credit crisis last year. But JPMorgan's Feroli said the Fed could have chosen to let AIG fail, just as it had done with Lehman.

"We don't know if the disease would have been worse than the medicine," he said. "We'll never know. But we know we lived through Lehman." He said the central bank needed to clearly explain when and why it would act to salvage a company in jeopardy or face the prospect of a long line of companies seeking bailouts.

Fed Chairman Ben Bernanke, who has stayed out of the public eye during the Lehman and AIG drama, is due to testify before a congressional committee next week and can expect some pointed questioning, Feroli said. "He needs to provide some sort of clear demarcation of what is or is not a systemic risk." "Of the many unconventional actions taken by the Fed in the current crisis, this may likely prove to be the most controversial and should make Bernanke's...testimony on Capitol Hill an interesting event."

American International Group Inc. fell 30 percent on speculation the government's takeover will ultimately wipe out shareholders. AIG dropped $1.14 to $2.61 at 9:39 a.m. in New York Stock Exchange composite trading.

The U.S. plan to save the New York- based company, the nation's largest insurer by assets, may give the government an 80 percent stake in return for an $85 billion loan, and dividends may be halted to common and preferred stockholders. They're already reeling from a 94 percent drop in the common shares this year.

The "punitive" interest rate on the two-year loan "makes it extremely clear that this is not a subsidy extended to keep the company afloat but rather a stranglehold that makes AIG unviable while ensuring that its obligations will be met," said Marco Annunziata, an analyst at UniCredit SpA, in a note to clients. "This is to all extents and purposes a controlled bankruptcy."

AIG unraveled as the worst housing crisis since the Great Depression led to more than $18 billion of losses in the past year. A meltdown could have cost the financial industry $180 billion, according to RBC Capital Markets, because AIG provided insurance on more than $441 billion of fixed-income investments held by the world's biggest institutions, including $57.8 billion in securities tied to subprime mortgages.

The U.S. reversed its opposition to a bailout of AIG, after private efforts collapsed and the Federal Reserve concluded that "a disorderly failure of AIG could add to already significant levels of financial market fragility," according to a Fed statement late yesterday.

"It's an enormous relief," said David Havens, credit analyst for UBS AG in Stamford, Connecticut. "Nobody really knows what it would have meant if they would have been allowed to fail, but there was an enormous amount of systemic risk. The problem was, nobody really knew how bad it could have been."

The agreement will give the company, which sells insurance in more than 130 countries, time to sell assets "on an orderly basis," AIG said in a statement. Chief Executive Officer Robert Willumstad, 63, will be replaced by former Allstate Corp. CEO Edward Liddy, 62, according to a person familiar with the plans, who declined to be identified because the change hadn't been formally announced.

AIG's $2.5 billion of 5.85 percent notes due in 2018 jumped 8.25 cents to 53 cents on the dollar as of 9:29 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt yields 15.6 percent, or about 12 percentage points more than similar-maturity Treasuries, Trace data show.

The survival of the 89-year-old insurer fell into doubt when Standard & Poor's and Moody's Investors Service cut its credit ratings on Sept. 15. The reductions threatened to force AIG to post more than $13 billion in collateral when the company was already short on cash. AIG couldn't raise money by selling shares after the stock plunged to less than $4 a share from $70.11 in October of last year.

"There could be a greater need for capital" beyond the $85 billion, New York Insurance Superintendent Eric Dinallo told CNBC today, adding that the loan will give AIG time to sell units. The loan will "be sufficient to handle AIG's collateral needs" and allow the insurer to refinance debt as it comes due, said Wachovia Corp. analyst John Hall in a note today.

The Fed's loan doesn't require asset sales or the company's liquidation, though these are the most likely ways AIG will repay the Fed, central bank staff officials told reporters on condition of anonymity. Blackstone Group LP advised AIG on the transaction. The Fed doesn't have an expectation of whether AIG will be smaller, nonexistent or similar to its current form at the end of the loan's term, the staffers said.

The Fed or Treasury will end up holding the AIG stake, the staffers said. The Fed bailed out AIG while refusing aid to Lehman Brothers Holdings Inc., which collapsed earlier this week, because financial markets were more prepared for a Lehman failure, a Fed staff official said.

The Fed stepped in after JPMorgan Chase & Co. and Goldman Sachs Group Inc., which were brought in to help assess AIG, failed to come up with a solution, according to a person familiar with the talks. Liddy is currently on the board of Goldman, the company Henry Paulson ran as CEO before becoming the U.S. Treasury secretary in 2006.

Is the government planning on backstopping the entire economy in order to prevent a recession? How far is the government willing to go with respect to the degree of their overall involvement (financial resources, governance and oversight, etc) with troubled companies?

How far is the government planning on going with respect to getting into the "risk mitigation" business, in terms of constantly stepping into rescue Corporate America from its own incompetence? How far is the government willing to go in order to protect the economy from risk (or capitalism depending on your interpretation), in order to create a faux economy where nothing bad ever happens?

When it comes to the questions posed above, your guess is as good as mine. The only "line" we know much about (at this point) is the one that defines who the government will help, and that line seems to be drawn in terms of how entrenched a particular company is into the larger economy.

Because the bailouts/rescue/back-stops of Bear Stearns, the Mortgage GSEs and now AIG seemed to have been motivated more by the desire to protect their bond-holders, derivative holders, etc, etc, from facing significant financial risk (if not failing themselves) then it was about saving the companies receiving bailouts.

Of course, this scenario is arguably worse than a bailout (in of itself) as you're not only bailing out a bad company, you're also backstopping the risk of those who invested in an insolvent company/allowed themselves to get overexposed to same.

Think about it: AIG will have to pay back the loan in order to free itself of partial government ownership, whilst the bond holders will simply get to enjoy the backstopping of their risk without having to pay the government one red cent for the privilege. Doesn't that smell fishy to you?

At the very least, anyone who holds AIG bonds, derivatives, et al, should be forced to surrender some of their gains to the government in exchange for the government protecting their investment. Furthermore, if the government is going to engage in these sorts of activities more thought needs to be given towards how to funnel some of the financial benefits (assuming any exist) from these interventionists machinations back to the tax payers (special refunds, etc).

It's absurd that the taxpayer provides the cash to rescue these malaise ridden companies, protect bond holders, etc, but isn't even in line to receive any of the benefits. It's also not a bad idea to force bailed out companies to provide some sort of free or discounted service to low income Americans either. Just think about it: we have millions of Americans in need of health insurance, whose tax dollars were just used to bailout an insurance company.

Yes, I know AIG doesn't provide primary care insurance products, only supplemental and accidental injury ones, however the irony of uninsured taxpayers funding the bailout of an insurance company is highly disturbing to say the least.

Final Thought: American economic policy appears to be evolving to a place where we allow the financial sector to run amuck via minimal restrictions, and the Government is the ultimate parachute that removes risk from the equation. How can our economy survive if this is the way things are going to be on a go-forward basis?

I'm not so much questioning the government's rescue of AIG as I am the policies that got us to this point, policies that I don't see the government making any move to fix. Without a marked change to the way we regulate the financial sector, manage the economy, etc, we're just going to keep winding up back in these situations. I.e. "minimal regulation/bailout capitalism" isn't exactly a sustainable economic model.

Home construction tumbled a second month in a row during August, falling below expectations to the lowest level in 17 years. Separately, the U.S. current account deficit widened in the second quarter, pushed higher by rising oil imports.

Housing starts decreased 6.2% last month to a seasonally adjusted 895,000 annual rate, the Commerce Department said Wednesday. Single-family home groundbreakings also declined, and building permits fell sharply. Economists surveyed by Dow Jones Newswires expected August starts to drop by 1.6% to a 950,000-unit annual rate. The level of 895,000 was the lowest since 798,000 in January 1991.

July housing starts decreased 12.4% to 954,000, revised down from the originally reported drop of 11.0% to 965,000-unit annual rate. The July tumble reflected a payback for a surge the month before caused by a change to New York City building codes. The city had enacted a set of construction codes effective for apartment building permits authorized as of July 1, and builders rushed for permits during June to beat the deadline; that served to drive up U.S. starts and permits in June.

Wednesday's data showed housing starts year over year in August were 33.1% below the level of construction in August 2007. Building keeps retreating because inventories of unsold homes are so high. A report Tuesday by the National Association of Home Builders showed the trade group's latest monthly survey of builders' thoughts on market prospects rose, yet remained weak. The NAHB's September index measuring builder confidence climbed to 18 from a record-low 16.

The index gauges builder perceptions on new-home sales. The latest government data showed new-home sales were down 35% over the 12 months from July 2007. Analysts attributed the increase in the NAHB index to higher expectations for sales over the next six months because of the recent decline in mortgage rates.

"The main message here is that homebuilders still see extremely poor conditions in the housing market, and their expectations remain low despite some improvement," said Abiel Reinhart, an economist at JPMorgan Chase. Building permits fell by 8.9% to a 854,000 rate in August. July permits plunged 17.7% to 937,000. Permits are a sign of actual building in the future. The level of 854,000 was the lowest since 853,000 in February 1991.

August single-family housing starts decreased 1.9% to 630,000. Construction of housing with two or more units fell 15.1% to 265,000; within that category, groundbreakings of homes with five or more units -- or multi-family -- were 16.6% lower. Regionally, housing starts decreased 7.4% in the South, 14.5% in the Northeast, and 13.6% in the Midwest. Starts increased 10.8% in the West. Nationwide, an estimated 79,300 houses were actually started in August, based on figures not seasonally adjusted. An estimated 73,500 building permits were issued last month, also based on unadjusted figures.

The current account deficit increased to $183.1 billion during April through June from a revised $175.6 billion in the first quarter, the Commerce Department said Wednesday. The first-quarter deficit was originally reported as $176.4 billion. The current account balance combines trade of goods and services, transfer payments, and investment income. About 90% of the deficit is accounted for by the balance in goods and services.

The second-quarter shortfall of $183.1 billion amounted to 5.1% of gross domestic product, which was last reported at $14.313 trillion in current dollars for the three months ending June 30, 2008. The first-quarter gap of $175.6 billion represented 5.0% of a GDP of $14.151 trillion during January through March 2008. The deficit last spring was wider than expected. Economists forecast a current account deficit of $181.0 billion for the second quarter.

A $180.6 billion second-quarter shortfall in goods and services trade was bigger than the first-quarter's revised $177.1 billion; the first-quarter gap was originally seen at $174.9 billion. Second-quarter imports of goods rose to $553.6 billion from $528.8 billion; nearly half the increase resulted from an increase in petroleum and products. Exports of goods rose to $337.3 billion from $317.8 billion; more than half that increase resulted from an increase in industrial supplies and materials, including energy products. Oil prices likely affected the increases in value of petroleum trade.

The U.S. Securities and Exchange Commission stiffened rules against manipulative short-selling after a market rout pushed American International Group Inc. to the brink of collapse and triggered Lehman Brothers Holdings Inc.'s bankruptcy.

The SEC adopted two regulations today forcing traders and brokers to close out short sales on all stocks, amid concern investors are driving down prices by flooding markets with sell orders. A third rule makes it a securities fraud when sellers deceive brokers about delivering borrowed shares to buyers.

"These several actions today make it crystal clear that the SEC has zero tolerance for abusive" short-selling, SEC Chairman Christopher Cox said in a statement on the rules that take effect tomorrow. Lawmakers and regulators are questioning whether short sellers have contributed to a crisis by spreading false information and using abusive tactics to attack companies. Hedge funds and other investors argue that poor business strategies are to blame, not short sellers.

In traditional short sales, traders borrow shares that they then sell. If the price drops, they profit by buying back the stock, repaying the loan and pocketing the difference. The SEC rules approved today target so-called naked short- selling, in which traders never borrow shares from their brokers. The agency is concerned that such a strategy can free investors to manipulate prices by placing unlimited sell orders.

One SEC regulation eliminates an exemption for options market-makers to deliver shares of companies placed on so-called threshold lists. Companies are listed when they have a high number of borrowed shares that haven't been delivered. The rule will make it harder for options market-makers to hedge trades when they sell put contracts, said Stephen J. Nelson, a securities lawyer in White Plains, New York.

"If you want to short the stock you're going to have to deliver it, and the only way to really do that is to pre- borrow," Nelson said. `Professional traders are not in the business of taking that kind of risk. They would be very reluctant to face the five-day window because buy-in can be very expensive."

A second SEC rule imposes penalties on brokers if their clients haven't delivered shares to buyers three days after a short sale. For the specific security that hasn't been delivered, the mandate restricts brokers from conducting additional short sales on behalf of all their customers. The SEC will seek public comment on the change for 30 days.

The SEC also approved a rule drafted in March that would make it a fraud for investors to lie to their broker about locating shares to sell short. Currently, brokers are able to rely on their customers' assurance that they had located shares that could be used to cover a short sale.

The SEC rules don't reinstitute an "emergency" order that expired last month, which placed restrictions on short-selling in Lehman, Fannie Mae, Freddie Mac and 16 securities firms. The order required investors betting on a decline in stock prices to arrange to borrow the shares before completing a sale.

The SEC also declined to bring back the so-called uptick rule, which allowed short sales only if a preceding trade boosted a company's stock price. Lawmakers such as U.S. Senator Charles Schumer, a New York Democrat, have questioned the agency's June 2007 decision to remove the rule.

The fate of Washington Mutual remained in question yesterday as federal regulators recently called a number of banks asking if they would consider buying the nation's largest savings and loan should it eventually falter, sources told The Post.

In recent days, federal banking regulators have reached out to Wells Fargo, JPMorgan Chase, HSBC and several other financial institutions to gauge their interest in a possible acquisition of WaMu, but no merger discussions are currently under way between the Seattle-based bank and anyone else, sources said.

The move comes as investors worry that WaMu's customers could begin pulling their money, which totals about $143 billion, out of the bank should its stock fall further. That doesn't appear to be happening now, but several WaMu customers in the New York area told The Post yesterday that they were worried about their cash.

"Should I be in panic mode?" asked one Brooklyn-based customer who recently bought a $250,000 13-month CD from the bank.At the end of June, WaMu customers had 42.4 million accounts, almost all with less than the federally insured maximum of $100,000. WaMu's shares traded down as much as 25 percent yesterday before rallying to end the day up 16 percent to $2.32.

Standard & Poor's cut WaMu's credit rating to junk status late Monday citing "increasing market turmoil," but at the same time acknowledged that WaMu's deposit base appears to be stable and the company has enough liquidity to meet all fixed obligations through 2010. Rumors about a pending takeover by JPMorgan also resurfaced yesterday, but sources close to both companies said no talks are happening.

WaMu's deposits could buy the company's new boss Alan Fishman time to seek a deal or more capital should it lose more on bad mortgages than expected. In April, private equity giant TPG led a group of investors that pumped $7 billion into WaMu. TPG invested a total of about $1.5 billion into the company at an average price of $8 a share, according to a letter to the firms' investors obtained by The Post.

Those investors are unlikely to take a loss and would want JPMorgan or any other buyer to pay at least $8 a share before they accept a deal, sources said.

Speculation that Wachovia Corp. will ultimately decide to team up with another partner picked up again this week.

Wachovia, with its dominant Eastern U.S. franchise, is seen as a promising merger partner for a company with big banking ambitions. Trading in the bank’s shares Sept. 15 fueled sales talk as Wachovia saw its shares decline 25 percent to $10.71. The shares came back 7.5 percent to $11.51 in New York trading on Sept. 16.

Wells Fargo has long been seen as a merger partner given the San Francisco bank’s dominance in the West. But Morgan Stanley and Goldman Sachs might find themselves seeking to combine with a commercial bank, especially following this week’s buyout of Merrill Lynch by Bank of America.

Perhaps investors took to heart comments made by new Wachovia CEO Robert Steel on CNBC’s Mad Money show with Jim Cramer after the close of trading Monday. Steel outlined the bank’s challenges in its residential mortgage portfolio, which it picked up by buying Oakland-based Golden West Financial in 2006 — when the housing boom was in full swing across much of the country.

Steel said the bank has a big advantage in working through its problems because it has a direct relationship with mortgage borrowers that allows the bank to work out problem loans with borrowers. “We have lots of flexibility to figure out how to do this,” Steel said. “If we just owned securities, we would have two choices: hold or sell. “We have lots of choices,” he said.

Of Wachovia’s $500 billion in loans, only $10 billion are “problematic,” Steel said. “We have a lot of very good loans that are doing well, and we’re going to focus like crazy” on those problem loans. Perhaps the most interesting portion of Steel’s CNBC interview was when Cramer asked whether all the bank’s work is to prepare Wachovia to be sold.

“We have a great future as an independent company, but we’re a public company,” Steel said. “So we’re going to do what’s right for shareholders. I can promise you that. But we’re also focused on the very exciting prospects when we get things right going forward.”

Investment bank Morgan Stanley is weighing whether it should remain independent or merge with a bank, give the recent turbulence in the company's share price, broadcaster CNBC reported on Wednesday. Morgan Stanley officials were not in merger talks as of late Tuesday, CNBC said, citing unnamed people close to the matter.

"But senior people at Morgan concede that further zig-zags in the company's stock price could and possibly will force the company to change course and seek a merger partner, probably a well capitalized bank," CNBC reported on its Website. Morgan Stanley shares closed down 10.8 percent at $28.70 on Tuesday, having fallen 46 percent so far this year.

In an interview with Reuters on Tuesday, Morgan Stanley's Chief Financial Officer Colm Kelleher said the No. 2 U.S. investment bank remains confident in its broker-dealer model and dismissed the need to merge with a deposit-taking bank, even as he maintained a cautious stance about the markets.

Traders in Asian said the report weighed on share markets, which pared early gains made on the U.S. government rescue of troubled insurer AIG. "The U.S. government's rescue of AIG helped the markets to avoid the worst case scenario, but the fact that only the government was willing to help indicated the gravity of U.S. credit problems," said Choi Seong-lak, an analyst at SK Securities in Seoul.

"Reports that Morgan Stanley is considering a merger with a commercial bank confirmed such fears, and market participants are now wondering if even Goldman Sachs is safe. Sentiment is extremely fragile.

Lloyds TSB Group Plc, the bank that considered buying Northern Rock Plc before it collapsed, is in talks to acquire HBOS Plc after the mortgage lender lost three- quarters of its stock market value this year.

The banks are in "advanced talks," Edinburgh-based HBOS said in a Regulatory News Service statement today, without disclosing any details. A combination with Lloyds, based in London, would create a lender with a 28 percent share of the U.K. mortgage market, according to the Council of Mortgage Lenders.

HBOS's market value has plunged 80 percent from its 2007 peak to 9.4 billion pounds ($16.8 billion) on concern it might be the next bank to succumb to the funding shortage that forced the government to bail out Northern Rock. Prime Minister Gordon Brown's office said today it was ready to intervene in the banking market to avoid another collapse.

"People are very concerned about HBOS's ability to fund itself, and this would be a massive boost to Lloyds," said Simon Maughan, an analyst at MF Global Securities Ltd. in London. "Everybody has been wondering what Lloyds is going to do next. It would give Lloyds a hugely dominant franchise." Lloyds would ensure its capital ratios aren't eroded by HBOS, Britain's largest mortgage lender, two people familiar with the situation said earlier today. They didn't disclose terms and declined to be named because the talks are confidential.

HBOS, down as much as 52 percent earlier in the day, recovered after the British Broadcasting Corp. reported that Lloyds was considering a takeover. The shares were down 2 percent at 178.3 pence at 1:41 p.m. in London. Lloyds may pay less than 300 pence a share for HBOS, valuing an acquisition at no more than 15.8 billion pounds, said Ian Gordon, a London-based analyst at Exane BNP Paribas.

Lloyds rose as much as 18 percent and traded up 10 percent at 308.75 pence at 1:39 p.m., valuing the bank at 17.8 billion pounds. More than 62 million shares changed hands in the first two hours of trading, beating the daily average in the past three months, Bloomberg data show.

HBOS, which has about 20 percent of the U.K. mortgage market, gets almost half of its funding from capital markets. That compares with about 70 percent at Newcastle, England-based Northern Rock, which was nationalized in February after the first run on a British bank in more than a century.

HBOS "continues to fund its business in a satisfactory way," the U.K. banking regulator, the Financial Services Authority, said today in a statement. "A deal has to be done in the next couple of days, otherwise we are back to an untenable wholesale funding position for HBOS," said Martin Kinsler, a London-based fund manager who helps manage about $125 billion at Henderson Group Plc including Lloyds and HBOS stock.

Together Lloyds, the U.K.'s biggest provider of checking accounts, and HBOS would leapfrog Barclays Plc as the third- largest British bank by stock market value. "It's a very obvious deal," said Ken Murray, chief executive officer at Blue Planet Investment Management in Edinburgh. He has no holdings in any U.K. banks. "The cost savings would be enormous because the overlap is so vast and they would end up with a very dominant position."

HBOS, which employs about 72,000 people in the U.K., was formed in 2001 in the 9.7 billion-pound merger of Yorkshire-based mortgage lender Halifax Plc and Bank of Scotland in Edinburgh. Lloyds, which gets most of its funding from customer deposits, has skirted the worst of the credit turmoil compared with peers. HBOS and Edinburgh rival Royal Bank of Scotland Group Plc were forced to sell shares and pull back lending this year to replenish capital reserves eroded by credit losses.

Lloyds CEO Eric Daniels, 57, said in July the bank will consider acquiring weakened lenders. The bank weighed a bid for Northern Rock before the lender called on the Bank of England for emergency funding last September. Any potential takeover of HBOS would have no problem clearing government or antitrust hurdles, according to Simon Adamson, a credit analyst at CreditSights Inc. in London. "In more normal times, a tie-up between Lloyds and HBOS wouldn't even have been considered because of the competition issues," said Adamson. "These aren't normal times."

A merger of HBOS and Lloyds TSB could lead to as many as 40,000 UK job losses and 1,000 branch closures, rival bankers estimated, because of the huge overlap between the two banks. Unite, the trade union, rushed out a plea for no compulsory redundancies today in the face of what could be the biggest private sector cull in living memory.

HBOS employs 72,000 people while Lloyds has 70,000, in both cases almost entirely in the UK. In mergers of such similarly positioned organisations, as many as one third of the combined workforce can lose their jobs. The potential job cuts emerged as new figures showed that UK unemployment has risen to a nine-year high of 1.72 million after increasing by 81,000 in August. At the same time, the number of people claiming jobless benefits rose by 32,500 - the highest rate since 1992.

When Royal Bank of Scotland took over National Westminster Bank in 2001, 6,800 jobs were eventually lost. But there was much less overlap in that case because RBS was predominantly in Scotland and NatWest in England and Wales. One banker said: "There's massive overlap between Lloyds and HBOS. It's going to be unbelievably messy."

However, there is no certainty a deal would be done and it is not clear the extent of intervention by Government, which might insist on a soft approach to cost-cutting as the price of helping get the deal done. Job losses could be severe in branches, call centres, processing centres and the head offices of the two banks.

Lloyds operates one of the biggest networks in the country with 1,900 branches under the Lloyds and Cheltenham and Gloucester brands. HBOS has 1,100 branches, in many cases on the same high street. "Staff working in financial services must not pay the price for corporate greed," said Graham Goddard, Unite deputy general secretary.

Barclays said Wednesday it's paying $1.75 billion to acquire the U.S. investment banking and capital markets operations of Lehman Brothers in a cash deal that will safeguard thousands of jobs.

Most of the bill -- around $1.5 billion -- is to pay for Lehman's New York head office at 745 Seventh Avenue and two data centers in New Jersey. The remaining $250 million will pay for all of Lehman's U.S. fixed income and equity sales, trading and research as well as the investment banking businesses, which employ around 10,000 people.

The businesses being acquired have trading assets estimated at around $72 billion and trading liabilities of around $68 billion, but they include very little exposure to mortgages. Finance Director Chris Lucas told analysts that majority of the assets are in holdings such as quoted equities, government and agency paper and money-market instruments.

Less than 5% is in mortgage holdings and those assets are already written-down to the current market value. Barclays' President Bob Diamond described the deal as "a once-in-a-lifetime opportunity." The U.K. bank has previously said it wanted to take advantage of the credit crisis to grow its presence in the U.S. and it said Wednesday that the deal will give it a top-three position in U.S. capital markets.

The deal still needs the approval of the U.S. bankruptcy courts and CEO John Varley said it would be "impertinent" to speculate on whether that approval would be granted.

Banks are not the only ones struggling in the growing financial crisis. The fund established to insure their deposits is also feeling the pinch, and the taxpayer may be the lender of last resort.

The Federal Deposit Insurance Corp., whose insurance fund has slipped below the minimum target level set by Congress, could be forced to tap tax dollars through a Treasury Department loan if Washington Mutual Inc., the nation's largest thrift, or another struggling rival fails, economists and industry analysts said Tuesday.

Treasury has already come to the rescue of several corporate victims of the housing and credit crunches. The government took over mortgage finance companies Fannie Mae and Freddie Mac, and helped finance the sale of investment bank Bear Stearns to J.P. Morgan Chase & Co. Eleven federally insured banks and thrifts have failed this year, including Pasadena, Calif.-based IndyMac Bank, by far the largest shut down by regulators.

Additional failures of large banks or savings and loans companies seem likely, and that could overwhelm the FDIC's insurance fund, said Brian Bethune, U.S. economist at consulting firm Global Insight. "We've got a ... retail bank run forming in this country," said Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics.

Treasury Secretary Henry Paulson said Monday that the country's commercial banking system "is safe and sound" and that "the American people can be very, very confident about their accounts in our banking system." FDIC officials also have said 98 percent of U.S. banks still meet regulators' standards for adequate capital. But fear is growing on Main Street as well as Wall Street about the likelihood of multiple bank failures and the strain that would put on the FDIC.

The fund, which is marking its 75th anniversary this year with a "Face Your Finances" campaign, is at $45.2 billion — the lowest level since 2003. At the same time, the number of troubled banks is at a five-year high.FDIC Chairman Sheila Bair has not ruled out the possibility of going to the Treasury for a short-term loan at some point. But she has said she does not expect the FDIC to take the more drastic action of using a separate $30 billion credit line with Treasury — something that has never been done.

The FDIC's fund is currently below the minimum set by Congress in a 2006 law. The failure of IndyMac Bank in July cost $8.9 billion. Next month, Bair plans to propose increasing the premiums paid by banks and thrifts to replenish the fund. That plan is likely to be approved by the FDIC board, which consists of her, Comptroller of the Currency John Dugan, Thrift Supervision Director John Reich and two other officials.

Bair also is considering a system in which banks with riskier portfolios would be charged higher premiums, raising the possibility those costs could be passed on to consumers. A Washington Mutual failure would dwarf the largest bank collapse in U.S. history — Continental Illinois National Bank in 1984, with $33.6 billion in assets. By comparison, WaMu and its subsidiaries had assets of $309.73 billion as of June 30 and IndyMac had $32 billion when it shut down.

Arthur Murton, director of the FDIC's insurance and research division, said that when large institutions have failed in recent years, the hit to the fund has been about 5 to 10 percent of the company's assets. Standard & Poor's Ratings Service late Monday cut its counterparty credit rating on WaMu to junk, action that followed downgrades by both Moody's and Fitch last week.

Concern about the Seattle-based thrift, which has significant exposure to risky mortgage securities and other assets, has grown in recent weeks, and the company's stock price has plummeted. WaMu responded Monday by saying that it did not expect the S&P downgrade to have a material impact on its borrowings, collateral or margin requirements. The bank said its capital at the end of the third quarter on Sept. 30 is expected to be "significantly above" required levels and that its outlook for expected credit losses is unchanged.

Some analyst estimates put the cost of a WaMu failure to the FDIC at more than $20 billion, but other experts say it is very difficult to predict. Unknown, for example, is the amount of advances that institutions may have taken from one of the regional banks in the Federal Home Loan Bank system. Banks and thrifts have significantly increased their requests for advances, or loans, from the 12 regional home loan banks since the mortgage crisis began last year.

These amounts aren't publicly disclosed but must be repaid if a bank or thrift fails, notes Karen Shaw Petrou, managing partner of Federal Financial Analytics. If the FDIC doesn't have enough cash to cover the initial costs of a bank or thrift failure, one option would be short-term loans from the Treasury. That last happened in 1991-92, during the last part of the savings and loan crisis, when the FDIC borrowed $15.1 billion from the Treasury and repaid it with interest about a year later.

Based on projections of possible scenarios of bank failures, "between the (insurance) fund that we have now and our ability to draw on the resources of the industry ... we do have the resources" needed, Murton said Tuesday.Though short-term borrowing from Treasury for working capital may be possible, he said, tapping the long-term credit line is unlikely.

But Whalen said the Federal Reserve, the Treasury and Congress should "immediately devise" and announce a plan to backstop the FDIC with up to $500 billion in borrowing authority to meet cash needs for closing or selling failed banks.

"While the FDIC already has a credit line in place and this figure may seem excessive — and hopefully it is — the idea here is to overshoot the actual number to reinforce public confidence," Whalen wrote in a note to clients. "Simply having Treasury Secretary Hank Paulson or Ben Bernanke making hopeful statements is inadequate. Like it says in the movies: 'Show us the money.'"

Before Congress passed the law overhauling deposit insurance in 2006, about 90 percent of all insured banks and thrifts — considered to have adequate capital and to be well managed — paid no premiums to the FDIC. Today, all of them do.

There were 117 banks and thrifts considered to be in trouble in the second quarter, the highest level since 2003, according to FDIC data released last month. The agency doesn't disclose the names of institutions on its internal list of troubled banks. On average, 13 percent of banks that make the list fail. Total assets of troubled banks tripled in the second quarter to $78 billion, and $32 billion of that coming from IndyMac Bank.

Last month, Bair called those results "pretty dismal," but said they were not surprising given the housing slump, a worsening economy, and disruptions in financial and credit markets. "More banks will come on the (troubled) list as credit problems worsen," he said. "Assets of problem institutions also will continue to rise."

The 401(k) fund you've been dumping pretax earnings into for retirement may have shed a little heft. When the monthly update arrives from your brokerage, mutual fund holdings may seem like they have been on the South Beach diet. And the pension fund maintained by your employer could end up lighter as well.

Those are ways in which the collapse of investment bank Lehman Brothers Holdings Inc. and related turmoil on Wall Street on Monday could affect average investors, experts said. Stocks and bonds issued by Lehman, Merrill Lynch & Co. and troubled insurer American International Group are widely held by mutual funds, pension funds and individual investors.

"This is an extreme sort of event, and it will take days and months to figure out the precise consequences," said Amiyatosh Purnanandam, assistant professor of finance at the University of Michigan. But it will have an impact, he said. Problems in the banking sector will spill into the broader economy. If you want a business loan, a car loan, a home loan, a student loan, or virtually any other kind of loan, banks are hesitant to lend, and that in turn could hurt car and home sales.

People with 401(k) retirement savings accounts may be unaware of their exposure to problems at Lehman and other firms swept up in the turmoil, especially if they are unfamiliar with the holdings of stock and bond funds in which the retirement stash is invested, Purnanandam said. For example, the Fidelity and Vanguard families of mutual funds, as of June 30, were two of the largest owners of Lehman stock, holding 6% and 3%, respectively. Many pension funds also hold the stock.

But the State of Michigan Retirement Systems did not hold Lehman stock, said Terry Stanton, spokesman for the Michigan Department of Treasury. He said the $57-billion state retirement system had investments in insurer American International Group Inc. The system had 7.9 million AIG shares and is looking at a loss of about $66 million, based on AIG shares' closing at $3.75 on Monday.

He said it is important to note that the state retirement system has a diversified portfolio and going into Friday, AIG represented less than 2/10ths of 1% of the retirement system's assets. He said the system continues to perform well in comparison with other public pension funds around the country. As of June 30, the one-year return was a negative 4%, slightly better than other public plans. The three- and five-year rates of return are 8.8% and 10.2% respectively.

AIG is widely held by individuals and mutual funds. The nation's largest insurer has scrambled to find new capital. Holders of shares in Merrill Lynch, another Wall Street financial powerhouse scheduled to disappear in the current turmoil, will fare better. Each of the firm's shares will be exchanged for 0.8595 shares of Bank of America, which is taking over Merrill. In situations where brokerages go bankrupt, the government's Securities Investor Protection Corp. covers losses up to $500,000 in most instances.

JPMorgan Chase & Co. gave $138 billion this week in Federal Reserve-backed advances to the broker dealer unit of Lehman Brothers Holdings Inc. to settle Lehman trades and keep financial markets stable amid the biggest bankruptcy in history, according to a court filing.

One advance of $87 billion was made on Sept. 15 after the pre-dawn bankruptcy filing, and another of $51 billion was made today, Lehman said in court documents. Both advances were made to settle securities transactions with customers of Lehman and its clearance parties, according to the filing. The advances were necessary "to avoid a disruption of the financial markets," Lehman said in the filing.

The first advance was repaid by the Federal Reserve Bank of New York on the night of Sept. 15, Lehman said. JPMorgan said in a statement that the $51 billion advance was also repaid and the process will zero out the advances at the end of each day. U.S. Bankruptcy Judge James Peck in Manhattan approved an order confirming that advances JPMorgan is providing are covered by existing collateral agreements with Lehman and its affiliates.

JPMorgan holds about $17 billion in collateral to secure the money it advances to clear the trades, Lehman attorney Richard Krasnow said. "I believe the comfort order for the benefit of JPMorgan Chase under these clearance agreements, while unusual in my experience, is entirely appropriate," Peck said. There were no objections to the request. Requests to obtain a bankruptcy loan and schedule the sale of Lehman assets were postponed until tomorrow.

JPMorgan said in a statement before the hearing that it would "be unable to continue" making future advances needed to settle trades unless the court granted its claims special status. Both advances were "guaranteed by Lehman" through collateral of the firm's holding company under an agreement reached in August, according to the filing. The advances were made at the request of Lehman and the Federal Reserve, according to the filing.

Lehman disclosed the advances in a motion seeking court permission to give JPMorgan's claims special status in its bankruptcy and to certify they are guaranteed by Lehman's collateral. Lehman also said JPMorgan may make future advances at its sole discretion, all of which would be guaranteed by Lehman under the August agreement to pledge collateral. JPMorgan said the August accord, as well as a separate agreement made Sept. 9, guaranteed its advances. Both update a June 2000 clearance agreement between the companies.

Investment banks have been aiding or buying peers since the U.S. Treasury Department and the Federal Reserve established that its rescue of Bear Stearns Cos. in March hadn't set a precedent and declined to save Lehman before it filed for bankruptcy with debt of more than $613 billion.

JPMorgan is also reported to be working with American International Group Inc., along with Goldman Sachs Group Inc., after AIG was told not to expect a loan from the central bank. Merrill Lynch & Co. agreed to be acquired by Bank of America Corp., leaving Goldman Sachs and Morgan Stanley as the two largest remaining investment banks.

Signaling the depth of the current financial crisis, the money market industry, once considered to be a safe haven for investors, took a hit yesterday when the nation’s oldest money market mutual fund, The Reserve Primary Fund (RPRXX), lost value and “broke the buck.”

The fund fell below $1 in net asset value yesterday because of its exposure to debt from Lehman Brothers Holdings Inc., which filed for bankruptcy Monday. The event marked only the second time a money market fund has broken the buck.

The Reserve Management Co. Inc. of New York announced in a statement that redemptions could be delayed for up to seven days, but said those requests that came in prior to 3 p.m. yesterday would be redeemed at $1 per share. As of 4 p.m. yesterday, the firm’s board of trustees determined that the Lehman holdings had no value.

Shares of the money market fund are now valued at 97 cents. The fund had $62.6 billion in assets as of Sept. 12 and held $785 million in Lehman Brothers short-term debt, representing about 1.2% of total assets. “It’s likely to be an anomaly where The Reserve didn’t have deep pockets like everybody else [to offer support for the fund],” said Peter Crane, president of Crane Data LLC of Westborough, Mass., a money market research firm.

“I wouldn’t expect anyone else to follow this, though the hits keep coming. People need to keep it in perspective. Losing three cents on the dollar is not the end of the world.” In the only previous instance of a money market fund breaking the buck, Community Bancshares paid investors 96% of their principal in 1994, the Investment Company Institute reported.

Like a bad cold, Lehman Brothers' woes are starting to spread. Yesterday, New York investment firm Reserve Management Corp. told investors the value of one of its money-market mutual funds dropped below $1 a share due to losses on debt issued by Lehman.

Investors who want their money risk getting less than $1 a share - the first time this has happened with a money-market fund in over a decade. Other money-market funds - including ones run by Wachovia's Evergreen Investments and Russell Investments - are also feeling heat due to bad Lehman debt. But unlike Reserve, which brags of creating the world's first money-market fund, they have promised to make investors whole.

It may be weeks before the full impact of the contagion is known, but signs of infection are already cropping up. And it's not just stockholders, bondholders and employees who are getting sick. Since Monday, a host of groups, from insurance companies to hedge funds, have come out of the woodwork to explain to clients, shareholders - and occasionally, the public - what kind of fallout to expect.

There are growing concerns about contracts, known as swaps or derivatives, where Lehman is responsible for making a payment.And firms ranging from insurance company AXA to Houston-based Copano Energy have stepped up in recent days to explain their potential losses to Lehman as a result of these complicated contracts.

"Mutual funds, hedge funds, individual investors . . . it's very widely dispersed in terms of the pain that will be felt," said one hedge fund manager. When Lehman sells hard-to-value assets to raise cash, for example, it could hurt funds invested in similar assets - not unlike when a house being sold on the cheap drags down values of neighboring houses, he said.

Hedge funds that rely on Lehman to provide them with financing are also worried. The bankruptcy could force them to sell securities at losses. GLG yesterday announced it had transferred "substantially all" of its money away from Lehman to other prime brokerages. The "residual expose," wouldn't likely "be material," it said.

Global banks will have to raise at least $350bn (£195bn) in fresh capital to recoup their losses from the credit crunch, the head of the Financial Stability Forum (FSF) warned at the weekend. Mario Draghi, Italy's central bank governor and FSF chairman, said the protracted turmoil on financial markets would plunge more banks into difficulties and force the pace of consolidation in the sector.

His comments, at an informal meeting of EU finance ministers and central bank governors, came as reports said the Swiss bank UBS, the biggest European casualty of the sub-prime crisis, would write off a further $5bn this year.UBS has already written down about $43bn, while global banks have suffered write-downs and losses of $350bn in the past year.

Of these, €120bn have been absorbed by European banks, which may account for half of the estimated $1tn of asset-backed securities issued by banks. Draghi told reporters that banks had already raised $350bn to counter the crunch and would need to raise at least as much, if not more, in future - a figure far higher than previously anticipated.

"Various banks, within a sector that is basically well capitalised overall, will be in difficulty," he said. "The conclusion is that there will be a series of consolidations in the world banking system." Over the weekend, the former US Federal Reserve chairman Alan Greenspan said the credit crunch was "a once-in-a-half-century, probably once-in-a-century type of event" and called it the worst "by far" in his career.

"There's no question that this is in the process of outstripping anything I've seen, and it still is not resolved and it still has a way to go. And indeed, it will continue to be a corrosive force until the price of homes in the US stabilises. That will induce a series of events around the globe which will stabilise the system," he added. His best guess for that happening was in early 2009.

Draghi, meanwhile, insisted that banks in the 15-strong eurozone were not as exposed to reckless lending as others but the severe troubles at Northern Rock and several German banks have prompted serious concerns among EU policymakers.

The EU finance ministers and central bank governors, dominated by fears of contagion from the potential insolvency of the US investment bank Lehman Brothers, met to agree on new rules to regulate and supervise European banks. But sharp differences soon emerged.

Christine Lagarde, the French finance minister who chaired the "ecofin" meeting, said ministers had agreed that a single reporting system for banks and insurance companies would be in place by 2012. But this was disputed by EU diplomats.

The EU does, however, want banks and insurance companies to give full details of their exposure to securitised assets and any liquidity problems by the time they report their first-quarter figures next year. Common guidelines are due to be adopted soon. Lagarde said 80% had so far complied but 100% transparency was required to restore confidence among investors.

"It is vital to enhance work on the valuation of assets, particularly where the current market is still illiquid," she said.A French paper calling for a fresh group of senior financial officials to draw up new proposals for valuing asset-backed securities - more sophisticated than the current "mark to market" process - is understood to have met with a dusty response.

Alistair Darling, chancellor of the exchequer, questioned the need for fresh discussions, instead he urged action on implementing the "roadmap" set by the EU last autumn. Peer Steinbrück, the German finance minister, backed Darling's intervention in favour of sticking to the proposals for a global approach to stricter supervision established by the FSF.

Russia's Finance Ministry failed to calm the bedlam on the country's markets Wednesday despite aiding the banking system with extra liquidity.

At 0810 GMT, the Federal Financial Markets Service suspended trading on the Moscow Interbank Currency Exchange for the second consecutive day. The trading on the RTS benchmark also stopped after falling 6.4% in the first two hours, a day after its stocks saw one of their worst meltdowns in a decade, falling 11.5%.

Shares of OAO Sberbank plummeted 17.3% while OAO VTB were down 11.5% before the suspension of trading. This came after the finance ministry's earlier announcement that it was extending the terms for depositing federal budget funds with the banks to three months from one month and increasing the total amount of the funds it was willing to put on deposits with commercial banks to RUB1.514 trillion ($59.35 billion), from RUB1.232 trillion.

Concerns have grown that the current liquidity chaos will surpass the mini-banking crisis of 2004. Confidence in the banking system has deteriorated sharply and lending has become scarce.

"We are receiving numerous calls from investors inquiring about some rumors going around in the market...about the collapse of Russian names, going from third-tier banks to ...Gazprom," said Trust Investment Bank analysts in a note. They added, however, that they advise to take all those rumors with "a lot of caution."

The central bank allotted a RUB340.28 billion rubles during the first repo operation Wednesday -- a record for the morning auction. The bank usually offers a second auction later in the day. Meanwhile, the finance ministry said it placed RUB118.68 billion of one-week deposits with commercial banks. The ministry said earlier that it was willing to place up to RUB350 billion.

Russia’s two main bourses, RTS and MICEX, said on Wednesday they were suspending trade until further notice from the state’s main market regulator as shares continued to tumble one day after their steepest decline in more than a decade.Russian stocks had continued to slide on Wednesday morning even as the government unveiled new anti-crisis measures to pump up to $29.5bn in extra budget funds into the three main state-controlled banks.

The dollar-denominated RTS was down 6.4 per cent and the rouble denominated MICEX was down 3.1 per cent when the suspension was enforced with the two main state-controlled banks, Sberbank and VTB leading the slide. Analysts said state cash being pumped into state banks was not being filtered into the rest of the system, which is being hammered by a liquidity squeeze as domestic investors faced margin calls on loans collateralised by shares.

”Russia doesn’t have a liquidity problem. It has an intermediation problem,” said Roland Nash, head of research at Moscow investment bank, Renaissance Capital. ”You can’t borrow on the interbank market,” he said.

Brokers have been pulling credit lines amid widespread fears of defaults as local clients saw leveraged shareholdings wiped out by the market slide. One Moscow investment bank, KIT Finance, said on Tuesday night it had failed to meet payments on several financial obligations because clients had failed to meet payments to it. The bank said on Wednesday that it was in talks with a strategic investor on stake sale. One potential suitor, VTB, however declined to comment.

In a sign of how the liquidity crunch in Russia is exacerbating the problem on local bourses, Russian depositary receipts traded in London were up on Wednesday morning. ”They have access to funding,” Mr Nash said. Russian shares suffered their steepest one-day fall in more than a decade on Tuesday, losing up to 20 per cent, as a sharp slide in oil prices and difficult money market conditions triggered a rush to sell.

The heads of the Russian central bank, the finance ministry and the financial market regulator met on Tuesday night for an emergency discussion on ways to halt the crisis. Earlier, trading had been suspended on both the Micex and RTS stock exchanges as investors ignored assurances by Russian officials and a cycle of distrust set in amid liquidity fears.

Margin calls forced domestic traders to liquidate positions and brokers pulled credit lines. At least one Moscow bank failed to meet payments. The rouble-denominated Micex Index closed 17.75 per cent down, the sharpest one-day drop since the August 1998 financial crisis, while the dollar-denominated RTS index closed down 11.47 per cent, its lowest lvel since January 2006. Interbank money market rates climbed to 11 per cent, their highest since a mini-banking crisis in summer 2004.

Chris Weafer, chief strategist at Uralsib investment bank: “We’re in completely uncharted territory where the prevailing emotion is of fear and numbnes. No one knows where this could stop”. Alexei Kudrin, finance minister, insisted that the financial system was not in a systemic crisis but the central bank injected a record $14.16bn in one-day funds into the money market.

The finance ministry also placed an additional R150bn ($5.8bn) in one-month deposits into the banking system. Konstantin Korishchenko, central bank deputy, told Russian news agencies that the bank and the finance ministry could provide a total of $117.6bn in liquidity to the banking sector.

But market players said banks were ceasing to lend to second and third-tier companies and brokers were pulling credit lines. KIT Finance, big Moscow investment house confirmed rumours that it had been unable to make payment on a series of short-term loans. It said: “In connection with the fact that a series of our clients did not meet their obligations to our bank, we have not met our obligations to our counterparties.

“We recognise our responsibility to our counter-parties and to the market and we are working intensively to resolve the situation.”Andrei Sharonov, managing director of Troika Dialog, a Moscow investment bank, and a former deputy economic minister, said: “This is a vicious circle,” said , . “It is a situation of total mistrust. The liquidity crisis is being caused by a crisis of confidence in which people are frightened to borrow and frightened to lend.”

Shares in Russia’s biggest state-controlled banks led the slide with Sberbank, the state-controlled savings bank, closing 21.72 per cent down and VTB losing 29.26 per cent. The bank was suffered on investor fears about its securities portfolio, which makes up about 10 per cent of its assets.

Argentina’s bond markets were savaged on Tuesday as credit risk rose to all-time highs amid a broader surge in risk aversion towards emerging markets. The move came as Russia’s stock market suffered its biggest one-day fall since the financial crisis of 1998, the South Korean won dropped by its most in a decade and the Ukrainian stock market fell 14 per cent.

Emerging market assets have been at the forefront of investor selling in the wake of the Lehman Brothers collapse because of fears over slowing world growth and increasing stresses in the global financial system. Nick Chamie, head of emerging markets research at RBC Capital Markets, said: “Emerging markets are reeling from a significant rise in risk aversion. We have seen this trend pick up since the start of the week.”

Argentina’s credit default swaps, the best gauge of credit risk, increased to 1,070 basis points, or $1.07m to protect $10m of debt over five years – the highest level since the Argentina CDS prices were first recorded in 2002. This was 120bp higher than Monday and 260bp higher than the start of last week as investors sold any assets considered risky. Investors fear that Argentina’s runaway inflation and spending plans could wreck its economy.

Venezuela, which also has high inflation and growing economic woes, saw its CDS jump to record levels. It rose to 1,083bp, a rise of 245bp on the day and 550bp since the start of last week. The selling pressure was just as intense on stock markets. The MSCI Emerging Markets Index fell 6 per cent to 776, its lowest level since October 2006.

Russian authorities were forced to halt trading after the benchmark rouble-denominated Micex index fell 17.5 per cent to 881.17, while the dollar-denominated RTS index dropped by 11.5 per cent to 1,131.12. Steven Dashevsky, head of research at UniCredit said: “The ferociousness of the decline we have seen is comparable only with the collapse of 1998. but you cannot ignore the fact that the underlying fundamentals are infinitely better than they were 10 years ago”.

Ukraine’s PFTS Index fell 14 per cent amid investor concerns over tensions with Russia and the collapse of the ruling coalition.Among emerging market currencies, the South Korean won tumbled 4.3 per cent against the dollar. The Turkish lira dipped to a four-month low against the dollar. The Brazilian real continued a fall that has seen it lose 7 per cent since the start of August.

Bill Ford Jr. came to Capitol Hill Tuesday to make sure that lawmakers don't confuse the loans that U.S. automakers are seeking with discussions of bail outs for the companies in the troubled financial services sector. Ford, the executive chairman of the auto company founded by his great grandfather, met with several members of the Michigan House delegation, as well as members from the five other states the company has factories in.

"I really think this is a very separable thing from Wall Street," said Ford, speaking to reporters after the meeting. "This is something that was already passed but unfunded. There was great familiarity among the membership long before we got into the" last few days, he said. Ford's message was echoed by lawmakers representing states that have significant auto industry presences.

"What's happening with the financial markets this week is, I'm sure, raising questions," said Rep. Candice Miller, D-Mich., who arranged the meeting. "This is not a bail out, this is a loan program." "It's a clear distinction between what's happening in the marketplace and what we're asking for," said Rep. Betty Sutton, D-Ohio. "They're not asking for a handout, this is about being able to move forward."

Auto makers are seeking $25 billion in low-cost loans from the federal government to help them invest in the next generation of cleaner vehicles. Several senior lawmakers have indicated in recent days they hope to fund the loans before Congress goes into recess at the end of next week.

Senior executives at the major U.S. car makers had been seeking an increase in the loans to $50 billion, citing the deteriorating credit markets as a reason why. But after the lukewarm response from lawmakers, they quickly backed away and focused their efforts on getting funds for the $25 billion.

The loan facility was created as part of an energy bill last year, but separate legislation is required to appropriate funds for the loans.The collapse of Lehman Bros. (LEH) and the forced sale of Merrill Lynch & Co. (MER) to Bank of American Corp. (BOA) sent the markets into a tailspin on Monday.

Ford said that the difficulties in the financial services industry should not be confused with the issues facing the auto companies.He did acknowledge that the events of this week had served to further tighten the credit markets, making it more difficult for companies to borrow money. "It's a very separate issue, but clearly an issue our country is facing," said Ford.

Gov. Arnold Schwarzenegger said Tuesday that he would veto a long-overdue state budget, and he threatened also to veto hundreds of other pieces of legislation, as the state’s 78-day budget crisis dragged on. The California Legislature finally passed a $104 billion general fund budget by potentially veto-proof two-thirds majorities early Tuesday morning, after setting a record for tardiness.

But Mr. Schwarzenegger, a Republican, said he would not sign it, or very little else, until a “good budget” was passed.“I say enough is enough,” he said at a news conference in Sacramento. “Californians have been put through this rollercoaster ride too many times.”

In particular, the governor asked for guarantees regarding contributions to a so-called rainy day fund, something he regards as critical to budget reform, which has become central to his second term in office. Mr. Schwarzenegger said he expected the Legislature to override his veto, but promised to return the favor by sending back most of the laws it passed in the last legislative session. “Every bill will be carefully evaluated and hundreds of bills will be vetoed,” he said.

Lawmakers on both sides of the aisle said they were prepared to override any budget veto. “Not getting your way is no reason to veto the state budget,” said Mike Villines, a Republican. “It is disappointing that he would take this unnecessary step that will only prolong our budget stalemate and cause more pain for many Californians.”

Karen Bass, a Democrat and speaker of the state’s Assembly, said a vote to override the governor’s veto could come as early as Wednesday. Leaders on both sides admitted that the budget that was passed was a disappointment and that lawmakers were likely to face similar problems next year. “We tried,” Ms. Bass said. “But we weren’t able to do anything better.”

Under the bill, the state would close a $15 billion budget gap with about $9 billion in cuts and additional revenue essentially borrowed from future tax payments. Some tax exemptions, including business losses, would be temporarily suspended, and some loopholes would be closed.

Republicans in the Legislature had refused to consider new taxes desired by Democrats. And because California law requires two-thirds majorities for tax increases, several proposals, including a one-cent increase in the sales tax, were nonstarters.All of which led to more than a little frustration.

“This is not a budget the Democrats or the governor wanted,” said Don Perata, a Democrat and Senate president pro tem. “It’s a failure. But Republicans had the final say — and they said no.” Tens of thousands of businesses, from child care to nursing homes, have been missing payments from the state as the crisis dragged on. Mike Danneker, executive director of the Westside Regional Center, a state-financed medical services organization in Culver City, said that his center ran out of money last Friday.

“These guys have been playing with this stuff for 77 days,” Mr. Danneker said. “They should have done this in May.”While Mr. Schwarzenegger’s veto announcement set the stage for a showdown with the Legislature, some experts said it was likely to be a lonely fight.

“Everybody has the votes to override him, so he doesn’t really matter anymore,” said John Ellwood, professor at the Goldman School of Public Policy at the University of California at Berkeley, “If I was a Democrat or Republican leader, I would say, “What has this guy given me?’ ” On Tuesday, at least, the governor seemed to be asking the same thing. “They are three months late with the budget” he said. “And this is what we get on the desk.”

Canadian Finance Minister Jim Flaherty said central banks will need to carry the weight of easing the global financial turmoil, while governments can do more to enforce better disclosure of losses.

"These are tools that are in the hands of the central bankers," Flaherty said in a telephone interview today when asked what can be done to alleviate the crisis. Group of Seven finance ministers and central bankers have been in "steady communications" over the past several days and agreed that policy makers may have to act in a coordinated fashion.

Central banks around the globe pumped emergency funds into money markets yesterday and today. The European Central Bank awarded $70 billion euros ($99.8 billion) today in a one-day money market auction, while the U.S. Federal Reserve added $50 billion in temporary reserves to the banking system. China opted to lower its interest rate for the first time in six years late yesterday.

Stocks and bond yields tumbled after Lehman Brothers Holdings Inc. became the latest victim of a yearlong credit squeeze yesterday, and on concern that American International Group Inc. won't be able to raise funds to keep that company afloat. Financial institutions worldwide have reported more than $500 billion in losses and writedowns.

Flaherty said governments from the world's richest economies must do more to ensure financial institutions fully disclose losses they've incurred. Canadian lenders have been transparent and forced to raise capital, he said. "The market and the regulators and the departments of finance and the central banks need to know that that assurance is there that we will not have further significant negative events," he said, declining to single out any country or institution.

Exposure in Canada to Lehman's collapse is "limited," Flaherty said. The finance minister also said the slowing U.S. economy hasn't undermined the federal budget surplus, which is "slightly ahead" of projections. Canada has forecast a budget surplus this year of C$2.3 billion, down 77 percent from the previous year.

Manulife Financial Corp., Canada's largest insurer, may hold as much C$1.36 billion ($1.27 billion) in debt sold by American International Group Inc. and three other "troubled" U.S. financial institutions, according to BMO Capital Markets.

The holdings, based on 2007 filings, represent about 0.8 percent of Manulife's invested assets, BMO Capital Markets analyst John Reucassel wrote today in a note to investors. The figure includes investments in Lehman Brothers Holdings Inc., Washington Mutual Inc. and Wachovia Corp., he said.

Canadian banks plunged for a second day following the bankruptcy of Lehman Brothers and the credit downgrade of AIG, the country's biggest insurer. Canadian insurers including Manulife, Sun Life Financial Inc. and Great-West Lifeco Inc. also declined, though the Canadian firms have escaped with few debt writedowns. "While the Canadian lifecos cannot avoid all of these problems, we continue to expect them to outperform their global peers," Reucassel wrote in the note.

Manulife's debt holdings at Dec. 31 included C$196 million with AIG, C$328 million with Lehman and C$727 million at Wachovia.

Sun Life, the country's third-largest insurer, disclosed yesterday it may report a charge in the third quarter from C$334 million in bond securities and C$15 million in derivatives contracts linked to Lehman. Toronto-based Sun Life also owns about 400,000 Lehman Brothers shares and about 1 million AIG shares through its MFS unit, while Great-West, based in Winnipeg, Manitoba, holds 12 million Lehman shares and 14 million AIG shares through its Putnam Investments unit, the BMO Capital analyst said.

Toronto-Dominion Bank, the country's second-largest lender by assets, said its investments tied to AIG won't impact the Toronto-based bank. "Our exposure is within reasonable limits and a potential failure of AIG would have no material impact" on the overall operations, spokesman Nicholas Petter said in an e-mailed statement.

Royal Bank of Canada, the country's largest lender, had its biggest decline in almost a month, dropping C$1.60, or 3.3 percent, to C$46.50. The stock earlier plunged as much as 6.2 percent. "We manage and diversify our exposures in a variety of ways, including limiting our exposure to any single name and to any single sector," Royal Bank spokeswoman Beja Rodeck said in an e-mailed statement.

Toronto-based Manulife and other Canadian insurers may be in a position to buy assets disposed by AIG, Lehman Brothers and others, RBC Capital Markets analyst Andre-Philippe Hardy said yesterday. "Manulife is in a strong position to acquire these assets, in our view, given its existing expertise and scale in the market, and would likely be interested," Hardy wrote.

Still, Canadian insurers may be in no rush to buy troubled U.S. assets, said Gavin Graham, director of investments at BMO Asset Management in Toronto, which manages about C$54 billion in assets, including insurers. "I can't imagine there's any urgency on the part of any potential purchaser," Graham said. "Especially if things continue to unwind, you might be able to buy those in a few weeks anyway."

Shell and BP have been warned by investors that their involvement in unconventional energy production such as Canada's oil sands could turn out to be the industry's equivalent of the sub-prime lending that poisoned the banking sector and triggered the current financial crisis.

The criticism came as a report was released yesterday warning of the potential financial risks of tar sands, and members of the UK Social Investment Forum met in London to consider a Co-op Investments campaign on halting oil industry involvement in the carbon-intensive oil projects.

The report, BP and Shell, Rising Risks in Tar Sands Investment, co-authored by Greenpeace and fellow campaign group Platform, argues that oil majors are trying to make up a shortfall in conventional reserves by an irresponsible dash to extract oil from bitumen and other sources.

Mark Hoskin, senior partner at the ethical investment advisers Holden & Partners, expressed concern about the increasing focus on tar sands at a time when oil companies are being shut out of traditional drilling areas such as Russia and Venezuela.

"The recent banking crisis has shown how the financial markets can totally misjudge both the risks and values inherent in company balance sheets," he said. "Oil companies depend on oil reserves for their market values. BP and Shell are two of our most trusted UK stocks, but it is a shocking fact that 30% of Shell's oil reserves are in tar sands. "This report unveils how dangerous this approach is. There is a good chance that tar sands could be to the oil industry what sub-prime lending was to the banking sector."

The report lists trends moving against investment in this area, not least the decline in the price of oil at a time when the cost of developing tar sand schemes is rising, something highlighted recently by the boss of French oil group Total. The price of crude has plunged on world markets, with Brent blend briefly yesterday below $90 a barrel, down from nearly $150 in July, as traders fear that ructions on Wall Street following the collapse of Lehman Brothers will spread into the mainstream economy and drag down oil demand.

The report by the environmental campaigners also claims that low-carbon fuel standards under consideration by US presidential candidate Barack Obama and already implemented in California threaten to shut down sections of the American market to products derived from tar sands.

John Sauven, executive director of Greenpeace, said his organisation had always known that tar sands were a risk to the climate "but now it's becoming clear that they're a risk to the bottom line as well". Platform called on BP and Shell to rethink their entire energy strategy.

The criticism came as 20 members of the UK Social Investment Forum, a group of ethical investors, attended the Co-op Investments-backed meeting. The Co-op has called for a halt to new licensing of tar sands projects which, it believes, will tip the world into an irreversible process of global warming.

Paul Monaghan, head of social goals and sustainability at the Co-op, said the group was drawing increasing support and talks were planned with a wider group of investors. He expressed concern that BP and Shell had declined to attend yesterday and hoped they would be at future meetings.

Greenpeace and Platform say in their report that other risks to tar sands developments come from elections being held in Canada that could affect the regulatory climate, given that the opposition Liberal party is a strong supporter of a carbon tax. The NGOs also point to an "unrealistic" reliance on untested carbon capture and storage technology, which has been highlighted by Shell as a means for reducing CO2 emissions.

The Canadian tar sands are estimated to contain as much as 180bn barrels of oil but the environmental groups warn that extracting bitumen and upgrading it to synthetic crude oil is three to five times more greenhouse gas intensive than conventional oil extraction.

Upgrading a single barrel of tar sand bitumen for use in a conventional refinery also requires 14 cubic metres of natural gas, leading to huge demand for gas and supply infrastructure in remote regions of Canada. Enormous amounts of water are also needed in the process.

Shell argues that growing world demand for energy leaves society with little choice other than to exploit new forms of oil such as tar sands. BP, which insists it is still committed to the greener agenda set under former chief executive Lord Browne, said unconventional sources had the advantage of being located in politically stable countries such as Canada and it remained confident of the economics even at an oil price of $90 a barrel.

The company, now led by Tony Hayward, believes it can reduce its overall carbon footprint by keeping away from surface mining and being careful about the way it brings oil out of the ground. It insists it factored in the future costs of carbon in its tar sands projects.

"The Federal Reserve has requested that the Treasury Department deposit $40 billion with the central bank in an effort to help the Fed continue to stabilize the financial markets and address concerns about whether it is overstretched."

garth- yep, I knew too; but I'm still feeling like Bambi in the headlights today-

I find it dismaying that some people here can blithely state that the next "logical" step for someone they do not like will be "active support for some type of proto-fascist political entity". People may not appreciate "Insider", but this sort of accusation strikes me as out of bounds.

Someone else said that if Insider works at Goldman, then her thoughts and opinions are important to us, but if she works at Lehman, then no. Do people really think that because Lehman went out of business, all Lehman employees are idiots or dishonest?

A bit of discernment in comments would be greatly appreciated.

Elsewhere, Goritsas spoke of the strong points of the U.S. and that the country should not yet be written off. I agree, but would temper that optimistic view noting that very few countries are as indebted as the U.S. Unwinding that debt will make great deal of infrastructure unsustainable.

Over the past three years I've prepared the best I can, done my limited best, which is not all that much, but compared to most is something. I've tried to use my strengths to mitigate weaknesses, but my greatest skill is almost worthless economically--an appreciation of literature. For me, the value in literature is not what it says, but what it attempts to say, which only an individual reader knows. With that, here's a scene near the end of E.M. Forester's The Machine Stops that helps me calm down, think rationally about what is happening, and prepare for going out amongst them.

She burst into tears.

Tears answered her.

They wept for humanity, those two, not for themselves. They could not bear that this should be the end. Ere silence was completed their hearts were opened, and they knew what had been important on the earth. Man, the flower of all flesh, the noblest of all creatures visible, man who had once made god in his image, and had mirrored his strength on the constellations, beautiful naked man was dying, strangled in the garments that he had woven. Century after century had he toiled, and here was his reward. Truly the garment had seemed heavenly at first, shot with colours of culture, sewn with the threads of self-denial. And heavenly it had been so long as man could shed it at will and live by the essence that is his soul, and the essence, equally divine, that is his body. The sin against the body - it was for that they wept in chief; the centuries of wrong against the muscles and the nerves, and those five portals by which we can alone apprehend - glozing it over with talk of evolution, until the body was white pap, the home of ideas as colourless, last sloshy stirrings of a spirit that had grasped the stars.

Anyway, being an insider doesn't correlate well with being insightful. All too often it becomes difficult to see the wood for the trees. Personally, I've always preferred being an outsider.

His comments did make me think that it would probably be good to do a recap of our position for all the new readers who have found us recently, which is why I wrote such a long response two days ago.

Your comment about emotional responses is interesting. Humans are hardwired for emotions to be 'extremely catching', which is why we see reactions like panic selling. This is human herding at work. Learning to resist one's own gut reactions, in order to avoid the fate of the herd, is a large part of successful investing.

It took an extremely long time to finally get around to occurring, but it has occurred at an appropriate time. George W. Bush is going to go down in history as the president who destroyed America.

Capitalism is dead. Capitalism is as dead as communism.

What is going to replace capitalism? I hope ... nothing.

Technological civilization tetters on the edge of the abyss. I say: push is over the edge! Good riddance to both of you ... technology and civilization, the two most profound evidences of the human primates intrinsic suicidal insanity.

After the global economy collapses and the world becomes a very large and round planet again, the very last bubble will burst:

The human population bubble ... on a thoroughly trashed planet suffering all of the ill impacts of 10,000 years of cancerous civilization, the Earth is overpopulated to the tune of at least 90% already and the population continues to increase until the final human apocalypse occurs.

I am not troubled by the stock market collapsing, the banking industry collapsing, the United States government collapsing ... I spent today at a beautiful place and am pleased to see that after four billion years, Nature still owns the Earth.

Ric,Said: but my greatest skill is almost worthless economically--an appreciation of literature.

Ric, I passed 'The Machine Stops' on to my son years ago and he was very moved, much more than I was when I first read it almost half a century ago. Distance between parallels have greatly diminished.

As far as economical value of that skill of yours, where does one get better value for ones time than through an appreciation of the arts, particularly literature and music? I think without literature life must be a shallow sordid affair these days. (BTW, I paint so naturally, by right just of historical precedent, I discount any personal economic value there to me:)

Things fall apart; the centre cannot hold;

Tough stuff, eh !

What will hold though if that centre does not, except maybe myth. How are you at storytelling by the fireside ... could be economically advantageous in the future, eh?;)

Hmmm maybe I could set up a shop to do totem poles and body painting. Gee maybe we could go into business together call it Myth and Totem and then incorporate and franchise it out. Hey guys, don't worry, with literature to the fore civilization will soon be back in all its golden glory.

some people here can blithely state that the next "logical" step for someone they do not like will be "active support for some type of proto-fascist political entity".

I'm assuming you are in France?

I am genuinely curious about the period in French history during WWII and the Vichy government in France.

How did it come about? Was it just a German creation with collaborators or did it have any real traction with a signifigant portion of the population.How is that period in French history taught in schools?

I must confess my knowledge of the power structure is not enough to explain Vichy; a more impressionistic sketch can be found in the documentary "Eye of Vichy", a collage of Vichy propaganda films. The striking thing about that film is the near-absence of males between 18 and 45, the generation killed in WW1 or captured in 1940. All the spokesmen seem to be scared old men, desperately clinging to some semblance of authority.

I am feeling grateful to this blog for my feelings of calm today, prepared as best I can be for what is coming. No surprises to any of us here. I wonder if TOD realizes what a mistake in judgment that it made, yet.Ric--loved your literatureDave Matthews--I also like to take the big picture, thus my handle "Kalpa" which is Tibetan for "from one big bang until the next". Puts my place in this universe in perspective. Stoneleigh--Thanks, once again, for taking the time to write these past couple of days and share your valuable information with usz--as an outsider, I didn't do so badly myself, today.Kalpa

I, too, want to express my thanks to the hosts of this site. This is a nice little oasis of sanity for me.

I had one of those moments yesterday while sitting down with my "investment advisor" (barely out of short pants, full of excitement at how neat-o the market is). Had to break the hard news that I was fleeing the stock market for safer waters. Got the canned speech about how stocks are the best investment averaged over time, blah blooh bleah.

I told him I'd rather feel a little shame at getting the yips than lose it all in his fantasy world of swings and roundabouts. Actually, I didn't say that part out loud. I just needed to get home and moan for a few minutes.

There's something freaky about a disaster that you know is coming but you don't know exactly when. When it finally arrives, it feels like a strange mix of familiar and terrifyingly unforeseen. That's about where I am right now. Angry and sad at the colossal fcuking waste of average folks' time, energy, money, labour, and good will.

There will be bitterness. Bitterness is a political asset to be nurtured and harvested when ripe...

Someone else said that if Insider works at Goldman, then her thoughts and opinions are important to us, but if she works at Lehman, then no. Do people really think that because Lehman went out of business, all Lehman employees are idiots or dishonest?

That was me. But you misunderstood my meaning. I was trying to encourage insider to join the discussion in earnest instead of calling people who hold different views idiots.

What I said was that on this blog his credibility was determined by the caliber of his posts. Unlike the his day job where his credibility depends on who he works for. Reading back over my post I don't think I put very clearly.

Events are moving fast...very fast. I remember Emerson's words (circa 1861) -- "All the drops of my blood point downward." His world changed over the following five years ... ours world may be very different before the end of next week!

Christopher Whalen of Institutional Risk Analytics today opined that a retail banking run has already started in the U.S. and suggested that the U.S. Treasury needs to re-capitalize the FDIC to the tune of 500 billion dollars. I read his opinion after last night seeing a lot of chatter on various blogs concerning folks wanting to get currency-in-hand (i.e., "...my money out of the bank").

Confidence is waning among the most knowledgeable and I'm guessing amongst the insiders and critics, too. (Sad to say that all but one of the folks I come into contact with on a daily basis seem completely oblivious!)

Add to bank-run birth pangs the relative disappearance of gold and silver bullion on the retail level and one sees the prospect of safe harbor fading into an uncertain horizon. That said, I still would recommend the effort to acquire currency-in-hand, and silver and gold bullion in whatever proportions seem personally reasonable.

With regard to heavy entry into T-bills, the open bank vault in the U.S. Treasury and the speed of events make me question the wisdom of rushing into T-bills with the crowd -- they may make it difficult if one ever wants to rush out!

At times like these, I think less of the Yeats poem, and more along the lines of the immortal Max Webster:

"It's all over;Ya gotta hangover."

Arguably less classy, probably less anthologized in our better collections of modern poetry, but still a pretty solid summary of the situation. Except for the part about it not being over. Bonus points for CanCon.

As I noted above, below the Dow numbers, $70-80 billion vanished from the market cap of the big financials, in one single day.

Undoubtedly far more was lost if you add the thousands of smaller institutions. The big ones lost anywhere from 60% to 90% in the past year.

All that takes trillions of dollars in credit out of the market, as banks can lend out 10-12 times their capital.

And we are supposed to worry about $40 billion in Treasuries printed for the Fed? Karl talks about Weimar and Zimbabwe, and I just don't get it anymore. Where is the logic?

Sure, it's bad, it's all bad. It's large scale theft, as I've said more times than I can remember. It's the meeting of the five families, every single night. But still, hyperinflation is the farthest thing from my mind.

The money supply is shrinking like a prune in the Gobi desert, and two drops of water are supposed to make it grow like a baby whale?

Is it possible Bernanke and Paulsen are just starting to attempt to counterbalance U.S.deflation out by printing money? Will we see them print up several 100 million if Morgan and /or Wamu goes under?

Also, correct me if Im wrong, which is often, but my understanding of hyperinflation is that it doesnt happen in a vacuum. It happens "relative" to other strong international currencies. But how much strong currency is out there globally that is also not totally pegged already to the U.S. dollar. I'm thinking not much.

And we are supposed to worry about $40 billion in Treasuries printed for the Fed? Karl talks about Weimar and Zimbabwe, and I just don't get it anymore. Where is the logic?

Thanks for putting things in perspective here ilargi, now I can stop worrying about this new wrinkle and go back to shuddering beside the black abyss. --------- Hangedman the dollar dropped against the Euro and Yen today and gold went ballistic, ilargi will correct me if I am wrong I am sure, but I would say that much more of this and the US credit rating will be not a healthy one.

ilargi wrote ...$70-80 billion vanished from the market cap of the big financials, in one single day?

and

All that takes trillions of dollars in credit out of the market, as banks can lend out 10-12 times their capital.

At the risk of being pedantic, those numbers don't multiply up. However, my understanding was that banks could essentially lever 100X, not 10-12X, so the trillions figure is still correct.

But what about the CDS? Isn't the loss in stock market cap merely froth compared to the shadow banking system?

Like many of the posters here (ex-Stoneleigh and Ilargi), I still do not seem to have the required strength of conviction to 100% believe that the Fed won't try to print out of this and, if it does, what that means for my personal financial strategy. Alas, I hear Denninger and I hear S&I. And I see what's happening in the markets. In my mind, Denninger loses.

Having said that, a long time ago I asked Stoneleigh whether the Fed would print and, if memory serves, the answer was no; because in doing so, the Fed would lose its power (because the international bond market would cease to function). Stoneleigh, how surprised are you at what the Fed is doing? And, is this really printing?

garth said... I really would like to hear someone argue that this isn't as bad as it seems.

A major U.S. company declared bankruptcy on Monday, and another even larger company in the same industry that had come on hard times was bought by a yet larger company. We state the news on Lehman Brothers and Merrill Lynch & Co. in order to put this in context. American companies come and go, with catastrophic results at times for employees, shareholders, lenders and the general public. Enron, WorldCom, Digital Equipment Corp., Prime Computer and Data General were all major companies — some were household names. Their industries fell on hard times and redefined themselves, leaving shattered companies and lives in their wake.

Clearly the financial industry is in great trouble in the United States. Capitalism solves those problems by annihilating weak companies and clearing space for others to grow and for new companies to emerge. There is a term for this: “creative destruction.” It embodies the argument that, without the destruction of outmoded businesses, progress is impossible. It is interesting how badly damaged the old line brokerages have been. Merrill Lynch is an American institution that brought the stock market to the masses. Now something else will fill that space. If we knew what it was going to be, we’d be rich.

When this sort of activity occurs in the computer industry, or the dot-coms, hundreds of billions of dollars are lost. Lives are ruined and former paper billionaires look for jobs as programmers. When it happens in the financial industry, there is another concern. When Enron failed, many financial institutions shuddered and an accounting firm went down with it. When a financial institution fails, the deeper connections with other financial houses raise concerns about a ripple effect. Particularly given the daisy chain of leveraged debt, the fear is that the failure of one firm can trigger a chain reaction throughout the system. That may be true, but it is equally true that an Enron can undermine financial institutions and cause an uncontrolled chain reaction.

Of course, that didn’t happen. It is not clear that the failure of Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers and Merrill Lynch will cause such a chain reaction, either. One reason is the Federal Reserve, which is intervening in critical cases to dampen the effect. It is noteworthy that it did not intervene for Lehman Brothers, apparently calculating that the impact would not justify the effort.

From our point of view, the question is whether these failures will destabilize the United States sufficiently to affect the international system. We are simple folks and we look at simple things. The Standard & Poor’s 500 Index is down about 20 percent from its all-time high. The normal decline prior to a recession is substantially greater, and given Monday’s news, the situation could be much worse. A liquidity crisis increases the price of money, and yet interest rates remain low. That suggests we are not seeing a liquidity crisis, but simply an unwillingness to lend to firms that are failing. Most healthy companies outside the financial sector are securing financing, but the standards have tightened. That’s what is supposed to happen in an economic slowdown. Unemployment has risen, but nowhere near the dramatic numbers seen in the 1970s and early 1980s.

The financial industry is in enormous trouble. The financial system is certainly not experiencing the same pain as a Lehman Brothers employee is. It is not as well off as two years ago, but it is far from extreme straits. The economy has also slowed, but it is not clear that the economy is even in recession. The definition of a recession is simple: the economy contracts. If it does not contract, it may be slowing down, but that is not the same as a recession. At this point there is not yet confirmation that there is even a mild recession — although, as we have said before, it is about time to have one, since we are about seven years since the last one and recessions are necessary correctives.

The only thing we can conclude from the data is that a lot of companies in the financial industry are in deep trouble, that the financial system itself is in much less trouble than this industry, and that the economy is doing fairly well, considering that it is probably heading into recession. The recessions of 1991 and 2001 came and went, and life went on. In spite of the horrific headlines in the press we see no reason to change that view. We would hate to be an employee of a brokerage house right now, but the United States has weathered much worse and it seems to us that the international balance of power will not shift. Certainly, if the numbers change dramatically, then so will our view. But we are struck by how much worse the numbers would have to get for us to re-evaluate our fundamental view.

It was terrible to be a mainframe computer manufacturer in the 1980s. It was awful to own an Internet company in 1999. And it is terrible to be in the financial industry today. That is not the same as the collapse of civilization as we know it.

There is an important distinction between short and long term treasuries. Short term treasuries are a cash equivalent that you will have no difficulty in extricating yourself from if you wait for 30-90 days (when the government will owe you your money back). There is generally no need to find a buyer due to the short timeframe and the risk of default is exceptionally low, at least for the foreseeable future. If the government were to default on short term treasuries, it really would be game over (try googling Russian GKOs in 1998 for comparison). Short term rates are likely to fall as money seeks a safe haven, but though your return will be low (at least in nominal terms), your capital should be safe.

Long term treasuries would probably require a buyer before the term was over. They amount to taking a bet on the long term finance of the US government. If long term interest rates rise, and I think they will, to reflect increased risk, then prices will fall. If there is a default, it is far more likely to be on long term bonds than short.

Basically, I think there will be a disconnect between long and short term interest rates, as the risk associated with the two is diverging. We recommend short term T-bills only, as a cash equivalent.

You said that "the economy is doing fairly well, considering that it is probably heading into recession".

The economy appears to be doing well because it lags events in the financial world. The contraction of credit is a leading indicator, and that indicator is flashing red. Where finance leads, the economy will follow, probably relatively quickly once we see a cascade in the financial markets. 2009 should be the year of panic for ordinary people, as the effects will be impacting heavily on the real economy by then.

Hello S & I,As OuttaControl's spouse, I too, would like to thank you for your insight (and willingness to share it) over this past year and a half (first with TOD). I watched OC freak out about Peak Oil and hoped it was a phase. Then you introduced him to Peak Everything and Economic Collapse! I was skeptical at the beginning, even when we visited your farm (that's an understatement… I thought you people were insane!). I “let him” convince me to sell our Ottawa house and move to the west coast where we could grow food year-round. I went along with the plan because he felt so strongly about it and we are a team. I’m not quite sure how I ended up “on the other side”, but in less than a year, I went from living an urban life in Ottawa as an interior decorator to someone who looks forward to reading your blog daily and looking for the perfect little homestead, away from the world in which we were raised to accept. We are currently renting a house but riding the real estate wave and gathering needed items for our very-near-future farm. I feel like we’ll at least be ahead of the herd, emotionally and financially, thanks to you.

I strongly agree with David Matthews and look forward to a different way of thinking, a different way of living and a different world for our children.

Is it possible Bernanke and Paulsen are just starting to attempt to counterbalance U.S.deflation out by printing money? Will we see them print up several 100 million if Morgan and /or Wamu goes under?

The Fed is just about out of the game. They've already done essentially all they can do. Now Paulson is trying to 'print money' and will probably continue to do so for a while longer. He's betting that he can restore confidence before he runs out of wiggle room, but the market will call his bluff, as it has done every time so far.

'Printing up' several hundred million will make no difference as the scale of the losses is so much greater. The problem is that deflation can proceed so quickly that no amount of 'printing' can keep up with the pace of credit destruction, especially when any money injected into the system disappears into a black hole anyway due to cash hoarding.

Paulson is setting the US up for the worst of both worlds - higher interest rates as the bond market reacts to perceived 'printing' and no extra liquidity to show for it.

I can't argue with your analysis...I'm probably guilty (again) of extrapolating a bit too far ahead of what appears the most probable course of events for the next year or so at least.

My pessimistic caution was prompted, although Ifailed to mention it in my comment, by internet chatter today concerning Standard & Poor's consideration of preliminary steps to review the AAA rating of the United States. That's a long way from an actual downgrade of course, but such talk would have been unheard of not too long ago!

The times they are a'changin' ... and I for one am very glad we have Ilagri and you as our guides.

Brain is working slowly after the day's events... I also wanted to mention another fleeting thought of worry concerning T-Bills -- the prospect not of outright admitted default, but of extension of maturities... Now that I've mentioned that I hope not to dream about it tonight!

I for one had a strange reaction for today, given the last 3 or 4 days. Oddly enough, it was one of relief. Having followed this blog since spring of '07, I came to more fully recognize the ramifications of these past few decades of debt-based economic growth. Evidence in support of the theory of what was happening emerged in the real world slowly over the last 18 months (so slowly, in fact that denial remained the dominant public refrain). We have had evidence of the scale of this crisis emerge more rapidly in the past few weeks and months. And this week, it seems we have crossed a threshold ... the cascades are noticeable to just about everyone now. We are now at the tipping point, I suppose ... if that is true, the system can and will unwind at breakneck speed.

It is certainly a sin, but it is a relief to see, finally, that "we are here." Theory has predicted reality. Now we can stop worrying and think about action.

... (well one theory anyway -- not the hyper-inflation nonsense, that one is built on a flawed notion of how additional money finds its way into people's pockets for spending in this current financial system -- hint, its not from the printing the fed has been doing....).

I asked Stoneleigh whether the Fed would print and, if memory serves, the answer was no; because in doing so, the Fed would lose its power (because the international bond market would cease to function). Stoneleigh, how surprised are you at what the Fed is doing? And, is this really printing?

The Fed, being privately owned and unwilling to throw away the seat of its own power, wouldn't 'print', hence they're essentially a spent force now when it comes to standing in the way of deflation. The treasury is still playing with someone else's money and is prepared to continue trying to order the tide not to come in for the time being.

It doesn't surprise me that they would do this, especially as they're really playing a confidence game rather than handing out truly enormous sums of money. They mean to imply that they'll do whatever it takes, but if they actually did, the US would get killed in the bond market for no real gain. At this point they feel they have no choice but to try everything to prevent deflation, and they may have enough hubris to think they can do it (ie outlast the market until confidence returns).

They know that the problem is global and that a cascade in the derivatives market (about $750 trillion) would be too big for anyone to bail out, so they do everything (whether legal or not) to prevent it. I don't think they can do it.

The losses have already happened, but they haven't seen the light of day yet. All it takes is for a firesale to revalue those assets, and huge amounts of putative value will disappear virtually overnight. Even more will vanish as the effects of leveraged losses work their way through the system, causing waves of subsequent defaults. The bubble is hollow, like Enron, and its implosion could be frighteningly fast.

Anonymous,outtacontrol, and cystairadio,Thank you all for your input yesterday. Just got home and reviewed it - that was very kind of all of you to give me feedback and I appreciate it.Now to start reading ilargi's literature for today.

CR:"Hangedman the dollar dropped against the Euro and Yen today and gold went ballistic, ilargi will correct me if I am wrong I am sure, but I would say that much more of this and the US credit rating will be not a healthy one."

As I said, I'm not agreeing with the video's content. I was just saying what i heard him say.

Extension of maturities is a possibility, but it would be extremely unlikely to happen until much further into a crisis, as it would cut off international debt financing. That isn't something a debt-junkie economy would do lightly.

Argentina did it - turned short term bonds into long term and then defaulted on them later. This is another reason why we suggest sticking to very short term instruments - if you keep an eye on things you should have adequate warning to move assets. That sort of thing wouldn't happen out of the blue - there would be warning signs, and we will be keeping a lookout for them.

Having said that, we are moving into an era of extreme risk on all fronts. There simply are no risk-free options. All we can do is to try to navigate through treacherous waters as best we can, but we may need to be both right and lucky.

I agree with what others have said. Financial planners will do what you tell them to if you insist, although they may well try to talk you out of it first. Canada Savings Bonds seem to be the best option on this side of the border for larger sums of money. It doesn't matter what the rate of return is because the point is to preserve capital. In a deflation, it is he (or she) who loses the least who comes out on top.

As for precious metals, holding some as an insurance policy would be reasonable if you have other bases covered and can afford to sit on them for a long time. You can buy them at Accu-rate branches (at least in Ontario), or you could buy them on ebay or Kitco. Buying anonymously is probably not possible though. Also, they will probably be cheaper later.

I lose track sometimes of where I have said what, given that I post to several sites and communicate privately as well. I may or may not have said here that it is possible that we could see a set of counter-trend rallies in precious metals, oil, the dollar and the euro. The larger trend for precious metals and oil is down, while the dollar has been rallying since March and the euro has been falling. I am expecting these trends to reverse temporarily before resuming their previous trajectory.

It is possible that this could coincide with a short market rebound following the step falls we have seen in recent days. No market ever moves entirely in one direction - there are always trends and counter-trends at all different degrees simultaneously.

stoneleigh,Thanks for your valuable comments. Not sure what my FP will say - he only seems to advise for products at this investment house - so I may be calling WG or a credit union or BMO or someone else to transfer stuff. I think I might be entering a huge learning curve re: communicating with "financial experts". But if my FP won't do what I want, I have no choice but to go elsewhere!

The comments tonight have been excellent! Not long ago, I was talking with some children at work while their chemotherapy was chugging in. They were all around ten years of age and discussing the meaning of greed in their play area after one child hoarded some sketchng material. One of the boys then stated, "but grownups are the most greedy of all"! Given what has been happening in the financial markets - his comments were quite stellar.

I agree with Ilargi. I see no inflation here. In my opinion (my opinion only) the $40 billion printed was solely to maintain appearances of legality. They are already doing enough questionable stuff but much of that is rather "exotic" and open to vague reinterpretation. Funding is not, so they are funding the Fed. As Ilargi notes, the speed of credit contraction far outstrips any inflationary pressures so far.

As for oil and gold, both had been oversold on the downside and should rebound a bit here. Ultimately, if there is any sort of economy after this, gold will be a way to move some wealth from here to there. Consider this like a time travel adventure. How do you get wealth from where you are to some future time where you have no idea what the economy and currency will look like? Gold is probably a pretty good bet for that. You could be wrong, but history suggests it's a good bet for getting from here to there, wherever "there" turns out to be.

Remember also that many (including Stoneleigh) have predicted that the government will try to inflate at some point. It's just that many of us no longer believe they can succeed, or that if they do succeed it will be far too late and not matter anyway.

If deflation flattens the world economy then all that inflation afterwards can do is rearrange the rubble.

This election does not happen (and, if it were to, it would be a selection for McCain/Palin) -- they cannot lose further control of what is going to have to become a fascist state to suppress mass social unrest (which you know is coming, but the only real question is when).

In losing control and creating "financial anarchy", I have serious questions they can hold it up long enough for people to get their Social Security checks October 1!!! Forget November 4 -- forget January 20, 2009... Do we even get through this month????

That sort of thing wouldn't happen out of the blue - there would be warning signs, and we will be keeping a lookout for them.

I&S: Can't thank you enough--(Note to self: remember the tip jar on payday!). What you write helps me sort through the barrage of nonsense that so many are shouting about the economy. I've never paid much attention to economics because economists never had credibility to me. Now, I eagerly read articles--and compare my interpretations with yours--and others. It's a real head's up. You guys are doing an extraordinary service.

Consider this like a time travel adventure. How do you get wealth from where you are to some future time where you have no idea what the economy and currency will look like?

Et voilá, there's your trillions. With this sort of selective quoting, and no, pedantic doesn't begin to cover it, I'm starting to think you joined the Palin campaign. And I don''t mean Michael.

SMICK!!

Having said that, I re-read your post and understand what you're saying now. The loss of all financial institutions "in the last year" is in the $trillions. Previously you mentioned "in one single day". I thought your $trillions referred to one single day.

Paulson does appear to be trying to print. That $100 billion can probably turn into $1 trillion in loans, if he can get the banks to take any risks again. But that's the question, isn't it? How to restore confidence once confidence is lost? I don't envy his task and still think he will fail.

To Starcade: McCain or Obama does NOT matter. If you think Obama and the Democrats matter, you are going to be very very sorely disappointed. But hey, I'm not the one placing my faith in an untried pretty boy. And no, I am not voting for McCain either. Ron Paul remains my intended write in candidate, purely as a protest vote and because he was right - we need to get rid of the Federal Reserve, the IRS, and stop acting like an empire.

Starcade, Yes. We will get through this month I think. The US government is not going to default next this month or next as far as I can tell.

GZ, I may just do the same when I go to vote. Bugs Bunny might work too - I bet he was opposed to the Fed as well.

S & I, Thank you for your service to the few of us who listen. I have made some few moves that I otherwise would have missed without the information you started me on and the subsequent reading I did on the topic. I'm still woefully unprepared for a fast crash, but it's better than nothing. By spring thaw my wife and I are going to have a piece of land and build.

We've decided we would rather pay a bit more for a chunk of land now and have time to prepare it than wait even longer and have the crisis deepen further...

Confused about this: "As I noted above, below the Dow numbers, $70-80 billion vanished from the market cap of the big financials, in one single day.

Undoubtedly far more was lost if you add the thousands of smaller institutions. The big ones lost anywhere from 60% to 90% in the past year.

All that takes trillions of dollars in credit out of the market, as banks can lend out 10-12times their capital."

Is it relevant how much "market cap" the banks have lost? AFAIK, how much money banks can lend out is based on their actual capital, not their market capitalization. Am I wrong?

(Granted, a company can raise capital by selling stock, but that is not typically how it's done, and the potential to raise capital isn't typically what's meant when talking about a bank's existing capital.)

Marianne, 'Vancouver Coin and Stamp' for discrete PM trading. I think up to 10,000 is no problem as far as identity, over that and you get problems as they have to record for reasons of possible money laundering.

I don't believe every word of it, no. But I am paying attention. I expect WaMu to fail. I expect bank runs.

Is that going to usher in the apocalypse? No. Is it going to mean the U.S. cancels its national elections and becomes a fascist state? No. If you believe that it will, then frankly you're slightly mentally ill (not permanently, I'm sure). Cannibalism is not just around the corner, okay?

I recently returned from a few months in Ukraine. That country is a complete shithole. There is about a 0.000001% chance that the U.S. economy will EVER be as shitty as Ukraine's. And you know what? Folks in Ukraine have sex, have kids, celebrate birthdays, graduations, and anniversaries, throw parties, play sports and games, etc., etc., etc.

You really just need to get a grip.

(And I loathe the Republican party, by the way -- I think I was born that way.)

We've decided we would rather pay a bit more for a chunk of land now and have time to prepare it than wait even longer and have the crisis deepen further...

I hear ya, Ebrown. But, get this, where we want to buy, the odd schmuck is actually taking his ridiculously overpriced land off the market only to re-list at a higher price!

As long as we don't have to go into debt to buy, I don't really care that the property will lose nominal value. I was telling intocontrol today that I officially hate money and what it does to me. I don't want to watch the markets and sit at this freakin' laptop forever wondering how to navigate this surreal world we call finance. But, for now, the reality is that we've got two kids and quite possibly some extended family that depend on us getting on a life raft of some sort, so I click away.

jon singler: There are only two alternatives for Nov. 5, and they both lead to roughly the same result...

Either you do "vote", and the whole thing in an orchestrated _s_election for McCain/Palin (McSame/Piglin, if you prefer), or the election never took place in the first place because events previous "forced" people (who had every intention of seeing this election cancelled) to cancel the whole she-bang.

The reason I am convinced that there will be a fascist state in the United States is because too many people are about to have nothing to lose by being violent. I've seen it -- I've lived it -- and now I see it exploding all over the damn place.

You can tell me I'm insane and go join that long line over there. But every sense of economic/financial/"stuff" value that this economy, culture, society, and nation have had over the last couple of decades is now _GONE_. Kaput. Finito. Etc.

I'm glad you are trying to delude yourself that something is going to fix this. I can't delude myself that far, because I believe this whole thing to be an orchestration to an end -- no, an orchestration to THE end.

---

And one piece of advice to the Russians: Close for the rest of the week. Then you've got a few days to figure out what's next.

Like what she said --Oh, and private software in public voting machines? What, are we stupid?

“As I've frequently stated, I will never again vote in an election where I cannot use a paper ballot. For me to do otherwise, I believe, is to engage in a shell game of smoke and mirrors to which I will not sacrifice the preciousness of my right to vote in a so-called democratic republic.

As for my 2004 article, the world is remarkably different than it was then, and so am I. A larger, bleaker picture has emerged since then-one which for me calls into question the very process of selecting and electing candidates in the context of empire-in a culture of fascism, genocide, greed, corruption, and ecoside. It is that larger scenario that this article addresses.

For me, the first issue is the political system itself which is indistinguishable from the corporatocracy. The Democratic and Republican parties are de facto extensions of corporate America. Unless a candidate is systemically embedded in the corporatocracy, not only for the purpose of raising money, but in order to insure electability, she/he cannot succeed. Candidates from the Green Party or others such as Kucinich and Paul, are unequivocally consigned to the periphery, and while they may add fascinating nuances from the media-image perspective, they have exactly a snowball's chance in hell of prevailing. And while I could cast my vote for one of the peripheral candidates as a moral statement, it would be meaningless in terms of affecting change. In summary, if my vote won't make a difference, I'm not willing to cast it.” CELEBRATING UN-PRESIDENT'S DAY: WHY I WILL NOT VOTE FOR A PRESIDENT IN 2008, By Carolyn Baker

Well... I think one can make a pretty good case that we are seeing a fascist state develop right before our very eyes (if we haven't really had many aspects of one since Roosevelt!)... OK, OK, Jon S. ...I'll go put on my tin foil hat now!

GSJ

P.S. Stoneleigh - I think you're right...many thanks to both Ilargi and you for the comments/interaction last night!,

"I do not think we can look forward to a tranquil world so long as the Soviet Union operates in its present form. The only hope, and this is a fairly thin one, is that at some point the Soviet Union will begin to act like a country instead of a cause."

Great comments posted here.This one is for Easter Bunny and the remark that concerned the collapse of ciiization as we know it. I sense you doubt this will happen.

I have limited knowledge of finances and am probably gaining much more from this site than I am contributing. However, I do know the financial system is blowing up.Have you ever sat down and talking to someone who lived during the Great Depression? Poverty was rampant, there was no money - pension systems, banks, etc. went bust! People at stuff like rice and tomatoes as their only staple, day in and day out.And what will happen when there is no money to fund adequately our basic needs, such as healthcare and all its' related disciplines. Further, what happens when people can't afford their medications. Social uproar will occur resulting in violence which always results in tragedy.Then consider what happens in population health. We are due for another flu pandemic (perhaps H5N1) which could be as devastating as the flu pandemic of 1918. In a year it killed millions of people worldwide. And where will the money be to treat and care for these people, in addition to all the other pressing health care needs. I feel there is a very strong probability that we indeed could see the collapse of civilization as we know it.

"We Americans are either too incapable, or too dysfunctional, to help ourselves right now. Like drug addicts or the mentally ill who refuse treatment, we need our friends to intervene. So remember us as we were in our better moments, and take action to save us – and the world – from ourselves."

I don't know what everyone else's definition of a fascist state is but mine is one where the corporate, government and judiciary meld into one. Totalitarianism is where things like habeas corpus are shoved in the toilet and concentration camps established.

Ebrown and Outacontrol, now you guys don't get all antsy and impatient now. Baring some strange monster like hyperinflation swooping down use your time to wait on your greatest ally - deflation, haven't you been listening to Stoneleigh? I doubt that you will be able to replace later any CASH you use now as easily as you acquired it.

I would gladly pay you Tuesday for a hamburger today ... but what a price that will be, eh?

The comment about Ukraine is also true of Iraq, say my friends who still have family their. People get married, have kids, go to work (if they have a job) and some how life goes on (if you survive and don't move to another country). My comment is that given much of a collapse I expect the Iraqis (and maybe the Ukrainians) treat each other much better than Americans would. From what I am told their tendency to help each other out, their social networks and their extended families are much stronger than those in America. Also their expectation have never been as high as those of Americans. Dmitri Orlov makes pretty much this point.

The choice in the coming election seems to be between fascism and socialism. Which do you prefer: concentration camps or gulags? The election will occur (frankly I think the current administration looks pretty tired of playing the puppet) but it won't much matter who's elected.

CR says Baring some strange monster like hyperinflationswooping down use your time to wait on your greatest ally - deflation, haven't you been listening to Stoneleigh?

Yeah, I get that and I think Ebrown does too. But we (Ms Control and I) would like as much time as possible, while systems like credit cards and access to a world-wide range of products in every small town still exists, to "ease" into this new life. As you know, my recent experience with suburban poultry husbandry was a disaster. Or it would have been if I really needed Daisy's eggs. I figure it'll take at least 3 years until we can become somewhat reliant on ourselves and our new local community.

So it will be another matter of timing; the market has to drop so we can afford to buy, but we can't wait too long either.

I second what OC said. I do get it. It's worth it to me to start building up a place where we can meet many of our own needs. I have done alright with timing changes in the market as far as getting in and out safely, but I don't like it (what it does to me psychologically). I have too little confidence in the long term prospects of the dollar to try to wait until just before the crack-up boom in the international bond market before converting my dollars into real goods. I'd rather have the real goods now/soon.

“In 1932, at the height of the Great Depression, Helen and Scott Nearing moved from their small apartment in New York City to a dilapidated farmhouse on 65 acres in Vermont. For over 20 years, they created fertile, organic gardens, hand-crafted stone buildings, and a practice of living simply and sustainably on the land. In 1952, they moved to the Maine coast, where they later built their last stone home.

Through their 60 years of living on the land in rural New England, their commitment to social and economic justice, their numerous books and articles, and the time they shared with thousands of visitors to their homestead, the Nearings embodied a philosophy that has come to be recognized as a centerpiece of America’s “Back to the Land” and “Simple Living” movements.”http://www.goodlife.org/

I believe in helping other people and "sharing my pizza". I just don't believe in the federal government "making sure" that I do it. I support many programs on a state and local level that I would not on a national level.

"And so collapse, for you, is likely to turn out to be a deeply personal experience. Furthermore, if you manage to survive it, chances are, you will be none to eager to divulge the details of how you made it, for they will not be edifying. The process of survival is only enjoyable if it is experienced vicariously -- at someone else's expense."

D.M.:"I believe in helping other people and "sharing my pizza". I just don't believe in the federal government "making sure" that I do it."

No government "made sure" that the farmer's cooperatives in Western Canada functioned. They shared and grew together of necessity. Time and circumstance seem to be on a track to restoring that necessity.

I believe in helping other people and "sharing my pizza". I just don't believe in the federal government "making sure" that I do it.

Good for you. However, the vast majority of people will not share their pizza, and American citizens will starve, literally and figuratively. Some would say they get what they deserve. For every person that is mooching off the system there is someone who needs a hand. The question to our society then becomes - Do we aid them all, and thus help the able but unwilling? Or do we aid none, and hurt the willing but unable.

I second what OC said. I do get it. It's worth it to me to start building up a place where we can meet many of our own needs.

Sorry to shake your tree, I was just checking for squirrels and there seems to be none:)

By the way the Scott Nearing mentioned above I think is the same guy I heard about in the 80's who had left politics , I believe he was a senator or congressman, some such, and refused pensions as he felt it was unethical to be paid for something he wasn't doing work for. He seems to have done okay!

Yup, very busy. Nice to see so many busy here discussing complex things with half-truths and exaggerations.

Some thought questions: can you have simultaneous deflation and inflation? How is it different to create money through lending verus printing? When you 'print' money, where does it really come from? For that matter, where does money itself come from? How does market capitalization of a bank (stock price) impact the ability of the bank to make loans, take losses? If a financial entity has hundreds of billions of liabilities, does that mean something bad, good, or neither? The Federal Reserve is a private entity, technically a bank, yet they somehow control the money supply (even though someone here said they can't anymore) -- how do they get that power, and where do they get the money from? Is Fed/Treasury control over the dollar and money supply greater, less, or about the same when non-government entities are shrinking and/or deleveraging?

If you can't answer the above questions conclusively, convincingly, and with full explanation, you really don't have any place commenting on financial issues -- and most certainly not on some macro course of events.... (Sad but true, this disqualifies the vast majority of financial journalists as well.)

Correcting a serious error: In recent days, one of the various intro posts to the news claimed that the SEC had again banned short selling of the financials; presumably (though I didn't read it), this person also claimed the same ban on shortselling a few weeks ago.

However, this is grossly incorrect: the SEC banned *naked* shorting; you can still take a short position in any equity you want, as long as you arrange to borrow the stock *before* you sell it (rather than wait until settlement). Very big difference!

Also, there are lots of ways to get short a given equity even if outright short sales were banned, and though this site likes to talk about CDS, that would be a less likely choice for most fund managers.

Note that today, in a historic move, the FSA (Brit SEC equiv) did ban new short transactions....

On the CDS issue: I&S seem to delight in pointing out the trillions of dollars of CDS (notional) in the 'shadow banking system', generally with the accompanying claim that it is about to lead the world into disaster as it is all double counted, etc.

Well, over the past few days, many trillions of notional of all sorts of swaps have been unwound or netted out/paired off completely without a hitch! (True, lots of people worked lots of extra hours, but hey, Wall St catering is the *BEST*!) There may be a few small casualties in this (small trading books here and there), but so much for the global financial meltdown that has been postulated as a result of a failure of a major CDS counterparty....

The other day, Stoneleigh said that in preparation for the coming financial and systemic meltdown, most people would be best served by renting, rather than owning, their residence: I disagree.

Consider:- If we really do have a total collapse of the financial and payment systems, which is more likely to evict you and/or wring money out of you, a mortgage servicer who is servicing tens of thousands of mortgages, or a landlord who is managing a few rental units? Your odds of being able to successfully squat are far better with the mortgage servicer.

- If you borrow money to buy a house, you know your cost in nominal dollars for the next many years; if you rent, you know your cost for the next year or two. If you are my tennant, when it comes time to renew your lease I will look at comparable rents in the market, look at the cost it would take you to move, and I will set your upcoming monthly rent to the market rent + 1/12 the cost to move + a few dollars -- if you don't like that price, go ahead and move.... (Key issue: with a mortgage, if you have decent credit, you could take advantage of a competitive market to refi your mortgage; renting from me, you won't build much credit, and taking advantage of rental competitors will cost you a lot in transaction costs -- effectively, your transaction cost goes to me every year in the form of your rent!)

- The rental market is, of course, driven by supply and demand; with credit qualification and supply problems, we can expect that rents will rise (renting is an alternative to owning). And as those rents rise, your rent re-prices every year or two, as pointed out above.

Of course, if you don't have the credit or downpayment to be able to buy your residence, then of course you need to rent.

(Another way to think of all this: a rental contract penalizes you heavily for your inability or unwillingness to take on an ownership of the equity interest in real property; most people in most employment situations are vastly better served with a long-term stable payment though subject to the capital gain/loss on the real property equity, than taking the opposite position via a rental company. Think about it!)

(Also, please do think about what this discussion means in terms of concentration of power in finance: compare the competitive mortgage market versus renting a residence from a landlord: who has more power?)

This entire catastrophe highlights the now-common American response to any problem - 'It's not my responsibility.'

From the stupid greedy buyers of over-priced homes to the suited-monkeys blindly driving the massive financial institutions, their actions are the same - gimme gimme any and all profits, and it's not my problem when it tanks.